In this final week of the winter fund-raising season on Public Television, we are revisiting one of our most popular recent programs.  Ever since we launched WEALTHTRACK in 2005, one of the most discussed behavioral finance topics has been why investors underperform the very funds they invest in. We call it the “underperformance trap”.

One of the most dramatic examples involves a study Morningstar did of the top performing mutual fund of the decade from 2000 to 2009.  The fund delivered impressive 18% plus annualized returns in an essentially flat market. But the distressing reality was that the average investor in the fund during the same decade experienced negative annualized returns of -11%!

Joel Greenblatt
Image source: YouTube Video Screenshot
Joel Greenblatt

Why the huge discrepancy? The investors chased the fund when it was outperforming the market, buying high, and bailed out of the fund when it underperformed, selling low… thus missing out on the decade’s gains.

The reality is that even the best active managers have years of underperformance, a major reason so many investors are flocking to index funds instead.

According to another study of the same decade, 97% of the top 25% of funds spent at least three of the ten years in the bottom half of performance, 79% of them spent at least three years in the bottom quartile and 47% of the decade’s top 25% spent at least three years in the bottom decile.

You can understand why so many investors sell. No matter how much we say we are long term investors most of us lack patience. By the second or third year of trailing the market we are ready to switch to the funds that have been beating the market, and so it goes.

This week’s guest, Joel Greenblatt, has decided that rather than fight human nature he will work with it. He is both a great value investor and a financial innovator. He is Managing Principal and Co-Chief Investment Officer of Gotham Asset Management, a firm he founded in 2009 with his long time business partner and fellow investor Rob Goldstein.

He co-manages the Gotham Funds, long/short mutual funds, run like hedge funds but with much lower fees. The funds go long several hundred stocks the firm deems to be extremely undervalued and shorts hundreds of stocks it determines are very expensive.

His predecessor firm, Gotham Capital ran a very concentrated hedge fund with only 6-8 holdings.  After a ten year run, delivering 34% annualized returns he and Goldstein decided to close it to outside investors. Joel Greenblatt realized early on that most investors cannot emotionally tolerate years of market underperformance.

In early 2015 his firm launched a new fund, the Gotham Index Plus fund combining index investing with their actively managed long/short strategies.  He explains why he thinks this new hybrid approach could help solve the “underperformance trap”.

If you miss the show on air due to pledge schedule changes, you can always watch it on our website.  You’ll also find an EXTRA interview with Greenblatt about one of his major philanthropic interests, the Success Academy charter schools.

As always, we welcome your feedback on Facebook, Twitter or via the Contact Us link on our website.  We read all of your comments.

Have a great weekend, and make the week ahead a profitable and a productive one.

Best Regards,

Consuelo