Essential Takeaways From Chapter 9 of The Intelligent Investor: Investing in Investment Funds

Chapter 9 of The Intelligent Investor by Benjamin Graham delves into the topic of investing in investment funds. Graham offers insightful questions and describes things that investors should be wary of when it comes to buying into an investment fund.

Investment-Fund Performance

Graham opens the chapter by generalizing about investment-fund performance as a whole. He suggests that the average individual who has invested exclusively in investment-fund shares in the past ten years has fared better than the average person who made direct common-stock purchases.

Graham also notes that investors who open brokerage accounts with the idea of making conservative common-stock investments are likely to face inconvenient influences in the direction of speculation and speculative losses. These temptations should be much less for the mutual-fund buyer.

Questions for Investors

Graham sets out a number of questions that investors are likely to ask themselves when considering investment-fund purchases, including:

• Is there any way by which the investor can assure himself of better-than-average results by choosing the right funds?

• If not, how can he avoid choosing funds that will give him worse-than-average results?

• Can he make intelligent choices between different types of funds — e.g., balanced versus all-stock, open-end versus closed-end, load versus no-load?

Performance Funds

In this section, Graham seeks to answer one of the inherent questions he pointed out above. He gives examples of widespread overvaluations either intentionally malicious or by the nature of investment funds posting better than average results.

Graham notes that the increase in fund prices may have come from the fact that the folks creating and running these "performance funds" had a tenure short enough to have only experienced the bull market of 1948–1968. These "performance funds" were led by large commitments in newer ventures at prices completely disproportionate to their assets or recorded earnings. The prices were only justified by:

• Naive hope for the future accomplishments of these enterprises.

• An apparent acumen in exploiting the speculative enthusiasm of the uninformed and greedy public.

Graham also speaks to the impact of management tactics and ethics on the fund itself. He believes that the intelligent investor should be aware of some "Extraordinary Popular Delusions" brought about tactically by fund management. He's talking about the exploitation of regulations that can cause financial statements to be deceptive in their representation.

In the past, fund management has made decisions that strictly benefit the management instead of including fund participants. Often these types of decisions even adversely affect fund participants by imposing additional fees up-front or through fund strategy.

Graham gives credit to some funds that have lasted and done only slightly better than the market over the long term (greater than 10 years). These funds currently tend to be open-ended funds that are closed to new investors. Meaning that the managers have stopped taking in additional cash.

While this reduces the management fees they can earn, it maximizes returns their existing shareholders can earn. Closing a fund to new investors is a rare and courageous step.

Closed-End versus Open-End Funds

Graham then dives into answering the question of whether to purchase closed-end or open-end funds. Generally, he believes that investors should buy a group of closed-end shares at a discount of, say, 10% to 15% from asset value, instead of paying a premium of about 9% above asset value for shares of an open-end company.

Conclusion

In conclusion, Graham’s insights on investing in investment funds in Chapter 9 of “The Intelligent Investor” are still relevant today. Graham highlights the importance of being wary of performance funds, which may be overvalued due to short-term success or unethical management tactics.

He suggests buying closed-end funds at a discount rather than paying a premium for open-end funds and recommends avoiding funds with high loads. Furthermore, Graham advises against purchasing balanced funds for the bond component and instead suggests buying US savings bonds, corporate bonds, or tax-free bonds for a separate bond portfolio.

Overall, Graham encourages investors to be diligent in their research and analysis when considering investment funds. While investment funds can provide diversification and professional management, they can also be subject to pitfalls such as overvaluation, high fees, and unethical management.

By being aware of these potential issues and taking a long-term investment approach, investors can make intelligent choices and achieve better-than-average results.