A Mock Mutual Fund

by Robert Sheard
(TMF Sheard)

LEXINGTON, KY. (August 17, 1998) -- If you've read The Unemotional Investor, you may recall my commenting in the early sections that a recurring daydream of mine is to manage a mutual fund because, like Jim O'Shaughnessy, I'm firmly convinced it can be done mechanically with a terrific strategy and can outperform the market and the vast majority of actively managed funds.

To put my hypothetical money where my mouth is, so to speak, I began tracking a mock mutual fund in January for the Keystone fund. While I obviously can't mimic exactly what funds go through with daily cash flows, the procedure I've adopted at least puts the model to a more rigorous test by using the new rankings throughout the year and adding new money regularly, rather than simply testing one static group of stocks throughout the year.

Here's the procedure I'm using. Each Friday, I assume a cash inflow from new investors of $40,000. That represents a little more than $2 million in new money each year. Depending on the fund that can be wildly optimistic or wildly conservative, but it makes for a round number each week so that the performance being tested is spread out evenly. With that new $40,000 I buy the top twenty Keystone stocks, in roughly equal-dollar amounts, based on Friday's closing prices. Since the new rankings do come out during Friday's session, this price is not unrealistic.

I don't make any distinctions for stocks already owned. That is, if one stock stays in the rankings week after week after week, I keep buying more of it. I don't worry about industry diversification. I just buy the top twenty stocks every week. I have made no allowance for dividends and none for management costs. With a mechanical approach like this, a cost ratio of 1.25% should be about as high as you should expect, and the dividends on these blue chips will run somewhere in a similar range, so I'm going to call that a wash and keep it simple.

From January 2 through August 14, the fund has had $1,320,000 in cash deposits and the total value of the fund is $1,450,153, an unrealized gain of $130,153 to date. This represents an annualized return so far of 34.5%, which is roughly double the annualized return for the Standard & Poor's 500 Index so far this year. Not bad for a completely mechanical, very conservative, blue chip portfolio. And yet the portfolio's not been bulletproof. It holds 1,630 shares of Cendant <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CD)") else Response.Write("(NYSE: CD)") end if %>, which was absolutely hammered. It holds a small position in Computer Associates <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CA)") else Response.Write("(NYSE: CA)") end if %>, 190 shares, which has also been blasted. And it has a fairly ugly loss in Norwest <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NOB)") else Response.Write("(NYSE: NOB)") end if %>, not so much because it's been a big loser, but because it was in the rankings for quite some time and the portfolio bought 809 shares of it in the first few months. But despite those losses, it's performed admirably overall.

Obviously, the portfolio's also had some amazing winners: Dell Computer <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DELL)") else Response.Write("(Nasdaq: DELL)") end if %>, America Online <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: AOL)") else Response.Write("(NYSE: AOL)") end if %>, EMC Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: EMC)") else Response.Write("(NYSE: EMC)") end if %>, The Gap <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GPS)") else Response.Write("(NYSE: GPS)") end if %>, Home Depot <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %>, several drug stocks, even Safeway <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SWY)") else Response.Write("(NYSE: SWY)") end if %> and Wal-Mart <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:WMT)") else Response.Write("(NYSE:WMT)") end if %>.

Altogether, the portfolio has 49 different stock positions, ranging from as large as 6.8% of the total value (Dell Computer), down to a few positions as small as 0.1% of the total value (stocks that entered the rankings for a single week and then dropped back out).

As an interesting comparison, I did a similar mock fund with the top ten IBD-RS stocks each week. The annualized return was lower, only 25%, which makes me a hare suspicious about the consistency of that approach, despite its amazing results in some isolated groupings.

Nevertheless, I'll keep following the Keystone version and report on it from time to time.

Check out the latest file updates for the Workshop:
New Rankings | 1998 Returns | New Database

[Robert Sheard is the author of the The Unemotional Investor (Simon & Schuster, 1998) available now at Amazon.com and your local bookseller.]