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The way modern portfolio theory has it, for a diversified mutual fund to have any chance of consistently beating a broad index of stocks it should have fewer than 100 holdings, not trade too much, and keep fees to a minimum. But Ken Kam, president and CEO of investment firm Marketocracy, believes his fund disproves that theory. He has designed the Masters 100 Fund (MOFQX
) to have 100 managers -- mostly amateurs who won a spot on Kam's A-team by earning top returns on the virtual portfolios they run for the fun of it on the Marketocracy.com Web site. The fund is made up of nearly 1,000 stocks, has annual turnover near 200%, and expense charges of a hefty 2%.
Yet, somehow, this mutt of a mutual fund has managed to beat the market. In the past year it has lost 17% -- hardly something to cheer about, but still 6 percentage points better than the benchmark Standard & Poor's 500-stock index in that time. Since its launch in November, 2001, the fund has lost 6%, vs. the 17% drop for the S&P 500. It also scores in the top 10% of funds in Morningstar's small-cap blend category (small-cap funds that use both value and growth styles) in the past year.
"AMAZING RESULT." So far in 2003, the fund, which now has almost one-third of assets in gold and materials stocks, has lost 5%, vs. the S&P 500's 4% loss. Kam says the underperformance is because market dynamics shifted, perhaps only temporarily, to favor tech and large-growth stocks over the defensive and interest rate-sensitive stocks favored by the fund.
"It's an amazing result," says Kam, who believes Masters 100 has outperformed because he taps the Internet to find "undiscovered talent." Indeed, that was his primary goal when he launched Marketocracy: a way to test money managers and identify those with bona fide stock-picking skills. The former co-manager of the once top-performing Firsthand Technology Value Fund (TVFQX
), Kam left that fund in October, 1999, when it became so large that additional junior portfolio managers had to be hired. At the time, Kam says he was frustrated that there was no way to tell the good stock-pickers from the bad.
Kam uses software to identify the best stock-pickers out of nearly 55,000 volunteer participants on Marketocracy's Web site. Each month, he takes the top 100 performers and adjusts their raw returns to factor in investment style and trading activity. For example, a portfolio made up almost entirely of gold stocks would have to do better than a gold index for its manager's skill to earn a top ranking. Likewise, "If a portfolio with no trading would have outperformed, then trading subtracted from the performance," says Kam. "What you are left with is the amount of return that can be attributed to stock-picking skill."
THOUSANDS OF CANDIDATES. The portfolio changes each day to match the moves of the top 100 managers, each of whose portfolios are equally weighted in the fund. About 10 managers turn over a month, and about 25 managers have lasted since the fund's inception. Explains Kam: "We replace managers that underperform before they hurt the fund too much."
The process allows for overlap so even though Masters 100 has so many holdings, it isn't overly diversified. Morningstar currently lists the industrial materials sector as making up 36% of the fund and the top 10 holdings, including Gold Fields (GFI
) and Harmony Gold Mining (HMY
), constitute 27% of the fund. Playing low interest rates, the fund also has large stakes in financials, including regional banks and real estate investment trusts.
A lot of Kam's stocks are "deep value" -- the fund's forward price-earnings ratio is only 12.6, vs. the S&P 500's 16. But the Masters 100's average earnings growth is 27%, vs. a decline of 9% in earnings for stocks in the S&P 500. "On the whole," says Kam, "our companies are growing earnings, rather than reducing them, and trade at lower premiums."
TREND-SPOTTER? So far, the quirky fund has attracted only $16 million in assets, and fund pros are skeptical that it can continue to beat the market. "The basic premise just doesn't hold," says Russel Kinnel, director of fund analysis at Morningstar. He lumps it in with what he and others call "community intelligence funds" (most of which folded after the Internet era passed) that were designed to take advantage of some participants' specialized knowledge, say, about technology.
Although the Masters 100 can't turn on a dime, its holdings reflect sectors and strategies that have worked well in the past. Indeed, heavy reliance on small gold stocks and rapid turnover make the fund -- so far, at least -- something of a momentum vehicle. "Is this going to be a trend-chasing fund?" wonders Kinnel. The Marketocracy Masters 100 Fund is most likely too young, expensive, and untested to jump into unless your appetite for risk is pretty large. But its unique strategy makes it worth keeping an eye on, especially if it can continue its market-beating ways in these uncertain and volatile times.
Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column Edited by Beth Belton
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