What is the performance cult?

By Andrew Beattie AAA
A:

In the late '60s and early '70s, the bull market and media scrutiny of fund managers had made heroes of the so-called gunslingers of the go-go funds. Some of these managers were pulling off yearly returns of 60%. Investors would follow managers based on performance, moving their money from fund to fund to chase the hottest hands, leading to the name "the performance cult". This was encouraged by a large sales push by mutual funds, making the shares of funds much more liquid. The gunslingers were increasingly encouraged by the seemingly endless bull market to expand their buying into riskier areas, including small, illiquid stocks, to maximize returns. They also urged portfolios to cash in on any capital gains that would add to their total. If they didn't, they would be hit by a large number of redemptions as investors in the performance cult left the fund for a more aggressive manager.

Not everyone was caught up in the go-go funds, however. Paul Cabot, a pioneering mutual fund manager who made his name by speaking out against the excesses before the 1929 crash, warned that the focus on short-term performance was both wrong and dangerous. The gunslingers were pushing up already overvalued stocks by moving their fund's capital in for the momentum play, and looking less and less at the fundamentals. This overheated the market and added to the severity of the correction that came with stagflation in the mid '70s.

The go-go funds were the hardest hit by the turnaround in the bull market. The outsized returns of the gunslingers and their performance cult were going, going, gone. These funds were officially renamed "aggressive growth funds", but they could not stem the redemptions that continued for the next decade. Today the performance cult still exists, but there is comparatively less fund switching because the fees incurred from jumping fund to fund eat up modest differences in performance.

For further reading on mutual funds, see Picking The Right Mutual Fund, The Truth Behind Mutual Fund Returns and our Mutual Fund Basics tutorial.

The question was answered by Andrew Beattie

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