newjerseynewsroom.com

BY WARREN BOROSON

NEWJERSEYNEWSROOM.COM

BOROSON ON MONEY

One of the most memorable things about the 2011 baseball season was: the collapse of the Boston Red Sox.

Not long before the season ended, they were in first place. On Sept. 3, the odds were 99.6 percent that they would make the playoffs. And remember when the season started, they beat the Yankees in eight or nine straight games? They seemed like another Big Red Machine. They even beat the Yankees’ star pitcher, the 300-plus-pound C.C. Sabathia.

Well, the Red Sox didn’t even make the playoffs. They lost 18 of their last 24 games. And while I usually refer to the Red Sox as the “accursed” Red Sox – I’m a Yankee fan—even I feel a bit sorry for them. But, hell, I felt sorry for King Kong when he fell off the Empire State Building.

The Sox collapse reminds me of the decline of the Fairholme Fund, once the star mutual fund of the decade – and now losing shareholders right and left.

An even better comparison with the fading Red Sox might be with Fidelity Magellan, once the mighty ruler of the realm and now a one-star fund. It just lost its most recent manager. Where have you gone, Peter Lynch?

The Red Sox may have suffered from hubris, too much confidence. I mean, drinking beer during games. When I drink beer during softball games, my fast ball declines from 90 miles to 80. I’m talking about 90-80 miles a week.

With Magellan, it became too big. I suggested that the fund be split into two, but the manager I was talking to – who wanted the distinction of running the biggest fund – wouldn’t listen. (I don’t even remember his name.)

Bill Miller at the Legg Mason funds is another case of a star going nova.

The lesson, of course, is that things regress to the mean. Trees stop growing to the sky, Icarus falls to earth, “cowboys get throwed and horses get rode.” So, hedge your bets and don’t bet the ranch.

Baseball reminds me of investing in other ways. Baseball strategy changed not long ago (see the film “Moneyball”) and more emphasis was placed on certain statistics. On-base-percentage turned out to be important; stolen bases, not.

In investing, Morningstar revolutionized the world of mutual funds by rating funds. In the old days, you’d look at a fund’s one-year record, five-year record, three- year record, ten-year record — and throw up your hands.

Now Morningstar blends the three-, five-, and 10-year records, and gives you one single rating. And punishes funds for excessive volatility. I’ve read that 80 percent of funds sold today have high Morningstar ratings. (Similarly, Charles Gorin revolutionized bridge playing by introducing a simpler way of evaluating the strength of a hand rather than the old cumbersome Culbertson method.)

Another thing. Star baseball players grow old, and baseball is so competitive that losing a little spring to your swing, or a little zip on your fast ball, turns you into a second-rate player.

Veteran fund managers may face the same fate. When their fund becomes successful and money pours in, they are challenged to continue doing well – even while buying bigger stocks and lesser bargains. These huge handicaps help explain why so many mutual fund stars fade away.

To continue: Rookie baseball players are initial public offerings. A few become big stars, but many fade fast. (To misquote Francois Villon, where are the IPOs of yesteryear?)

Open-end funds are regulation baseball. Closed-end funds are cricket. Cricket is somewhat like baseball but…strange, complicated. A lot of foreigners play.

Small-cap stocks are young ballplayers. Volatile, easily injured, temperamental. Big-cap stocks are veterans. More reliable.

Growth stocks, like Apple, are .300 hitters or 20-game winners. Everyone wants them on their teams, but they’re expensive. If they go into a slump, or just get injured, you’ve taken a big loss.

Value stocks are onetime .300 hitters who have been in a prolonged slump. Or 15-game winners who hurt their arms. They come cheap. Some deserve to be cheap. It’s not easy to correctly identify the players who have a good five years left and those who will be selling insurance in a few months. But a player who emerges from a slump, or whose arm heals, can be a godsend. Similarly, one of the few things we really know about the stock market is: Value, over the years, beats growth.

Fixed-income funds are defensive shortstops who hit .220 and average four home runs a year. But they can add stability to a portfolio.

Specialty funds – energy funds, health funds – are specialized baseball players. They can hit only left-handers or right-handers…or they can pitch only one or two innings. Sure, you might buy specialty funds, but your core holdings should be diversified funds.