Persistency of Performance

02/04/2005 12:00 am EST

Focus:

Sheldon Jacobs

Author, Investing Without Wall Street, Five Essentials for Financial Freedom

Since 1991, Sheldon Jacobs has offered a strategy called Persistency of Performace, based on buying the previous year’s top-performing diversified no-load US stock fund. Here, he explains the success of the approach and his choice for the coming year.

"We know that past performance does not guarantee future results, and many investors have bought a fund with a strong track record and watched its performance melt away. Nevertheless, our methodology is different from many others who look at top ranked funds as a predictor of future gains. We only select diversified funds, which benefit most from continuing management expertise. Almost all other such studies include sector funds, whose performance is much more erratic and whose managers can seldom overcome the drag of an out-of-favor sector.

"Similarly, our strategy avoids funds that are largely short, because bear markets are less likely to persist than bull markets. Finally, our strategy has benefited by our use of a one-year time frame. The market moves in cycles, many of which last about three years. An investor buying on the basis of three year returns might be investing at the tail end of a cycle. When investing is based on a single prior year’s performance, the danger of buying too late in the cycle is greatly reduced. Overall, backtested to 1975, this strategy has beat the benchmark in 19 of 28 years. In only four years did the strategy produce an actual loss. On average, our picks have gained 20.3% per year, vs. 13.8% for the average diversified no-load US stock fund.

"Our selection for 2005 is Baron Partners (BPTRX). While it is number one without qualification, we would note that it is technically non-diversified according to SEC regulations. This means it may have large positions in a relatively small number of companies. Nevertheless, the fund is eligible for Persistency of Performance because portfolios with as few as 20 holdings can be diversified. In fact, concentrated funds accentuate the manager’s stock picking ability, which this strategy seeks to capture, and may be particularly important in 2005.

"Baron Partners is the ‘best ideas’ portfolio of Ron Baron, the founder of Baron Funds. The group’s investment team attempts to identify long-lasting immutable trends, and then picks the industries and attractively valued stocks that can benefit. The fund’s top holding at the end of the third quarter was Wynn Resorts (WYNN NASDAQ), which accounted for 19.1% of the fund’s assets as of last September. Other major holdings include Apollo Group (APOL NASDAQ), which runs The University of Phoenix, and ChoicePoint (CPS NYSE), a leader in background checks and insurance databases. Baron also likes nursing home operator Manor Care (HCR NYSE) and homebuilder, Toll Brothers (TOL NYSE).

"Investors in Baron Partners do run the risk of one or more of Ron Baron’s major picks hitting a rough patch and causing major losses in the fund. As such, this fund is for the speculative part of one’s portfolio. But that’s generally true of our Persistency of Performance selections. Baron Partners now owns about 30 stocks and has more than $500 millioon in assets, up from $286 million in September. Note also that the fund may establish short positions. It currently has about 2% of its assets shorts and another 10% of assets in cash."

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