For a while it worked. Two of the previous winners talked with good temper about what they had done and would not do again. They would no longer have such a limited view of history: the limited view of history said that you don’t sell good stocks in a decline because they’ll come right back. They would no longer go into illiquid situations, no matter how great the promise. They would no longer fall in love with stocks, forgiving the first lapse, and then the second lapse, and so on all the way down.

  “We didn’t pay attention,” said one speaker, which was to say everybody had paid attention to ten or fifteen stocks but not to Vietnam and Cambodia and the Federal Reserve and Washington and the world at large. Another speaker was going to laugh if somebody said, “There is only a limited supply of stock.” And still another speaker was going to disregard his clients, or potential clients, especially the ones who, when you were bearish, would say, “Call me when you’re more optimistic.”

  Snug in its chairs, the audience was warm and responsive. It was all going along well. Then I tapped David Babson. I should have known better what was coming. Babson is a crusty, amiable New Englander who heads the sixth biggest investment-counseling firm in the country. He was then just turning sixty. For a couple of years he had been preaching and scolding. The stock market, he had said, was becoming “a national crap game.” If the sinning didn’t stop, he had told other groups, if the whole “gigantic parimutuel operation” didn’t stop, there would be government intervention.

  Babson had told me once that when he brought good grades home from Harvard to the family farm in Gloucester, Massachusetts, his father was down in a vegetable garden. The Babsons are 1630 New Englanders, but Yankees, not Brahmins. In addition to running the farm, Babson’s father was the local veterinarian. Babson walked the length of the field and told his father the news. “That’s good,” said his father, “but you been home ten minutes and you still don’t have your overalls on.”

  Babson had not always been scolding; in fact, his weekly letters proved him to be a cheery optimist and a bull on America in the late forties, a time in which the surrounding opinion was quite gloomy. He had started the weekly letter because, when he began his counseling service in 1940, “there was no line outside the door.” In Babson’s view, the most prized virtues were hard work and common sense—not smartness or cleverness, but common sense—and these virtues would triumph in the long run. Babson read off a list of eleven villains, which I will come back to in a moment. I picked him up on a statement: Was this terrible market due to the professionals?

  “Of course,” he said. “Nobody else. The professionals, people who ought to know how to manage investments, got sucked into speculation.”

  “What do you think we ought to do about this?” I asked.

  Babson looked over his glasses at the audience.

  “Some of you should leave this business,” he said.

  There was nervous laughter. I asked him if he had anybody in mind.

  “Some of them have offices near here,” he said.

  I said I didn’t know anybody with an office near here.

  “Some of them are sitting quite close,” he said. “When a prospect for a new account asks how much growth he can expect, and we tell him ten percent, and he says somebody else has promised him twenty percent a year, we ask him which Fred promised him that.”

  By sheer coincidence, there were some very well-known aggressive portfolio managers named Fred. We had one, by another coincidence, sitting with us. (Later, each of the Freds was to express resentment at having been lumped in with the other Freds.)

  “Too many Freds,” I heard Babson mutter, and then he said, “Should a manager who put Parvin Dohrmann into a client’s account be allowed to advise anyone again?” Parvin Dohrmann had gone from 142 to 14.

  “I have a list here,” Babson said. He pulled it out and began to read.

  “Four Seasons Nursing Homes,” he said. “The high was ninety-one and the low is bankrupt. Anybody that went to bed with Four Seasons—”

  “David,” I said gently into the microphone. The audience was beginning to rustle. You can tell something has happened to the good feelings when the water pitchers start to clink nervously against the water glasses in a rising cacophony.

  “Commonwealth United,” he said. “The high was twenty-five and the current price is one. Susquehanna, the high was eighty and the current price is seven. Unexcelled, the high was sixty-eight and the current price is four. All great institutional favorites.”

  “Don’t read the list,” I said.

  The audience was beginning to scrape its chairs. My massive group therapy session had taken a sour turn. Nobody was going to confess if they were being accused.

  “Computers,” Babson said. “Management Assistance, forty-six to two. Levin-Townsend, sixty-eight to three.”

  “David,” I said.

  “Leasco Data Processing, fifty-seven to nine. Data Processing and Financial General, ninety-two to eight.”

  “David,” I said, “you have passed the pain threshold of the audience.”

  He stopped. The audience was absolutely silent. Well, I remember thinking, maybe catharsis was the wrong idea anyway. Maybe Sinners in the Hands of an Angry God is more appropriate.

  “Thank you, Jonathan Edwards,” I said.

  Babson did not get a standing ovation.

  We had questions from the audience. There was one rather plaintive one for Babson, which showed that my original idea had at least taken hold.

  “Isn’t there just one mistake of yours that you could point to?” the questioner asked Babson.

  That got the applause.

  Babson said he could find a few if he dug hard, but no serious ones. Babson’s own fund had taken seven years to double when others were doing that in months, but it had held its ground while the others melted away.

  “My host asked me what my strategy is,” he said. “It is the same this year as for any year. To try to use our common sense.”

  I asked all my other winners whether the game was coming back. They all said that sooner or later it was. Except Babson.

  “No greater period of skulduggery in American financial history exists than 1967 to 1969,” he said. “It has burned this generation like 1929 did another one, and it will be a long, long time before it happens again.”

  “The day I went to work in 1932,” Babson said later, “steel mills were running at eight percent of capacity. I remember days when the trading was so slow people played ball on the floor of the exchange. The ticker didn’t move at all, and then Armour crossed at $4 a share.

  “After the war, I pushed growth stocks when today’s performance managers were in their playpens. The Census Bureau predicted the U.S. population would be a hundred and sixty-five million—in 1990! I was a radical then, and maybe I’m a curmudgeon now—times change, the economy changes—but another group has to grow up out of the playpens and the scars have to heal before you do it all again.”

  I said that was pretty optimistic.

  “Maybe so, but common sense will go a long way to help.”

  Here is Babson’s list of villains:1. The conglomerate movement, “with all its fancy rhetoric about synergism and leverage.”

  2. Accountants who played footsie with stock-promoting managements by certifying earnings that weren’t earnings at all.

  3. “Modern” corporate treasurers who looked upon their company pension funds as new-found profit centers and pressured their investment advisers into speculating with them.

  4. Investment advisers who massacred clients’ portfolios because they were trying to make good on the over-promises that they had made to attract the business.

  5. The new breed of investment managers who bought and churned the worst collection of new issues and other junk in history, and the underwriters who made fortunes bringing them out.

  6. Elements of the financial press which promoted into new investment geniuses a group of neophytes who didn’t even have the first requisite for managing other people’s money—namely, a sense of responsibility.

  7. The securities salesmen who peddle the items with the best stories—or the biggest markups—even though such issues were totally unsuited to the customers’ needs.

  8. The sanctimonious partners of major investment houses who wrung their hands over all these shameless happenings while they deployed an army of untrained salesmen to forage among even less trained investors.

  9. Mutual fund managers who tried to become millionaires overnight by using every gimmick imaginable to manufacture their own paper performance.

  10. Portfolio managers who collected bonanza incentives of the “heads I win, tails you lose” kind, which made them fortunes in the bull market but turned the portfolios they managed into disasters in the bear market.

  11. Security analysts who forgot about their professional ethics to become storytellers and let their institutions be taken in by a whole parade of confidence men.

  This was the “list of horrors that people in our field did to set the stage for the greatest blood bath in forty years,” Babson said. The doctor in Pocatello, Idaho, did not by himself think up the idea of buying Liquidonics and Minnie Pearl, and the man on Main Street didn’t decide on his own hook to buy “a new El Dorado mutual fund which has since flushed half its assets down the drain.”

  Well, that is a handsome list of villains. I have the feeling that in Babson’s part of New England the stocks they put you into for not having common sense are the wooden ones down on the village green that are very uncomfortable for the hands and feet. In retrospect, there is nothing wrong with Babson’s list except that the villains do overlap and the excesses are seen as totally within the industry. There were, as we have seen, some macro-villains that also helped to set the stage: there was the unpaid-for Vietnam war with the concomitant inflation, and those responsible for that; and there was the antiquated structure of the securities industry, and those responsible for that. Four of Babson’s eleven villains were investment managers guilty of one sin or another, and three were people in other roles in the securities industry proper—partners, analysts, salesmen—who ignored their professional responsibilities.

  I brought Babson’s list in here to show that there was a lot of finger-pointing within the industry, and that if you have a secret hurt, so did a lot of the professional managers. If you bought an “El Dorado mutual fund,” you may have hurt right along with those managers.

  Which brings up a pertinent point: suppose that all this business about the Federal Reserve and the market and the swings makes you too nervous. Suppose you want to leave it all to the pros. You go to your bank and let them manage the money. Or you buy a mutual fund. How would you have done? (For, after all, it should be pointed out that many funds were not “El Dorado” funds, and that the vast majority of American securities by market capitalization were not promotions but mature American companies. They may not have produced gains for their investors, but that may be due to other reasons having more to do with their own basic natures and the broader market forces.)

  A simplistic answer has to precede the statistical one. If you bought a mutual fund that went up, you did well. There were such funds. If you bought one that went down, you did badly. There were such funds, too. And there were banks that made money for people, and banks that lost money for people, and investment counselors that did the same. This point is brought up for a very obvious reason: you have to do something with the money, and just because you invest it does not mean you have to be the median or the average. Somebody has to be first and somebody has to be last, and one hopes to be closer to the former than the latter.

  Now to the sources. They are familiar to those in the industry that care about such things, and they include the obvious: The Institutional Investor Study Report of the Securities and Exchange Commission, especially Volume 2; The Comptroller’s Staff Reports from the Office of the Comptroller of the Currency; Bank Trusts: Investments and Performance; and the work done by several academic institutions, notably the Wharton School of Finance at the University of Pennsylvania. From the latter came the best-known statistical job: sponsored by the Twentieth Century Fund, it is published as Mutual Funds and Other Institutional Investors, by Irwin Friend, Marshall Blume and Jean Crockett. In addition, there are a number of academic papers, usually heavy in mathematics and statistics, published in such professional journals as the American Economic Review, the papers of the American Statistical Association, and so on. And you can take your own samples from the Lipper computer runs of funds, since those have been done and the Weisenberger statistics from the mechanical age. For various reasons, I have had to go through much of this material as it came out, and I have talked, though not extensively, to the authors.

  This battery of citations is a defensive measure, for—as you might have guessed—the news is not so good, and some very well-paid manager might just come up to me in the shuttle line at the airport and swing if we say that managed funds with well-paid managers do about the same as a totally random portfolio. For that is what the statistics say, and we are back with our old friends from the freshman course, the random walkers. Here is a key sentence from the Wharton study led by Irwin Friend:Virtually all the published government and academic studies have indicated that the investment performance of mutual funds in the aggregate is not very different from that of the stock market as a whole.

  The Wharton study compared the mutual funds with random portfolios in New York Stock Exchange stocks:Mutual funds as a whole in 1960-68 seemed to perform worse than equally distributed random investments in New York Stock Exchange stock, but, except for low-risk portfolios, did better than proportionally distributed random investments.

  It isn’t necessary to go into the comparisons with the funds here—whether the random portfolios were weighted or unweighted (the Wharton people tried both) and the so-called beta coefficients, or degrees of volatility, in the portfolios. For some of the period of the Wharton study, the higher-risk funds—those so asperically charged by Babson—helped the overall performance of the fund industry. Because the Wharton study ended in September 1969, before those funds took their biggest bath, and a horseback guess would be that by factoring that in now, you would once again come out about even. These statistics do not count the sales commission of the fund (if it has one), so if you pay that, you have to start that much further behind.

  In other words, a random portfolio is just as good as the average mutual fund. Chicago’s Harris Trust tried another way: comparing the funds with the Dow Jones average and the Standard & Poor’s 500 stock average, for the twenty-five years ending in 1970. For half of that time, the median common-stock fund came in last, behind the averages. “There is no evidence,” says Professor Friend, “that any group of funds can beat the averages.”

  Of course, you cannot buy a statistically random portfolio, even though your portfolio may have a very random look about it. And you cannot really buy the Dow Jones average or the Standard & Poor. If you are going to buy a fund—or the equivalent slice in a bank-managed common trust—you have to buy that, and you hope that your fund or your bank is at the top of the list, helping the team against the randoms, and not at the bottom.

  There is at least one other important point in the Wharton study from the potential fund investor’s point of view. Adjusted for risk, the performance correlation in funds between one time period and another is zero. Professor Friend’s words, expressed also in the study: “There may be no consistency in the performance of the same fund in successive periods.”

  In other words, a fund that performed well in 1966 and 1967 may not perform well in 1969 and 1970.

  This is important, because many new investors came to buy funds for the first time, or were sold them, within the last five or six years. The funds that took in the most money the fastest from investors were those that had the hottest records for a short period of time previously. The investors who in 1967 and 1968 bought funds that had shown big increases in the year or two previous did unusually badly, worse than they had any statistical right to expect. Gerry Tsai’s Manhattan Fund, up 39 percent in 1967, went down 6.9 percent in 1968, 10.15 percent in 1969, and 36.80 percent in 1970. The Gibraltar Growth Fund, ranked third in 1968, ranked 481st in 1971; it threw in the towel and was taken over by the Dreyfus organization. Insurance Investors Fund, ranked fourth in 1968, ranked 317th in 1971. The Mates Fund, ranked first on some lists in a disputed finish in 1968, ranked 512th out of 526 funds in 1971. (Statistics by Arthur Lipper Corporation)

  The conclusions seem obvious. If you want to buy a fund, buy it, do not be sold it. There are magazines and publications —Forbes among them—which rank mutual funds over a period of years in all kinds of markets. You do need more than a year or two to judge a record. There are funds, and fund-management organizations, that have performed well for their investors over many years, consistently, in good markets and bad. And there are independent investment counselors who have done even better. It does take some investigation, however, a small enough price to pay.

  As a group, the professionals did not have a very good time through what happened. Some of them even suffered personally, which is to say that they checked out.

  3:

  CAUTIONARY TALES REMEMBER THESE, O BROTHER, IN YOUR NEW HOURS OF TRIUMPH