Why Has MFI Performed Poorly?

In Switzerland

Nice afternoon in Zurich.  Flight was a little more exciting than expected due to poor weather last night on East Coast. We took off about 2 1/2 hours late.  Then to add insult to injury, my iPhone slid under my airplane seat and I reclined it unknowingly and crushed my phone in the mechanism.  Luckily everything is backed up (I hope) to the iCloud.  Guess I will be getting a new phone next week and will have to work with an iPad this week.

I was asked a question on why MFI has under-performed or at the very least not materially out performed.  The table below shows my MFI Index year by year and in aggregate with the Russell 3000 Index:

	Annual		Inception to Date
Year	Russell	MFI	Russell ITD	MFI ITD
2006	11.40%	15.03%	11.40%	15.03%
2007	4.09%	-6.69%	15.96%	7.34%
2008	-37.05%	-37.97%	-27.00%	-33.42%
2009	32.51%	45.18%	-3.27%	-3.34%
2010	18.38%	22.77%	14.50%	18.67%
2011	-0.56%	-10.47%	13.87%	6.25%
2012	16.43%	9.70%	32.57%	16.56%
2013	33.01%	51.70%	76.34%	76.82%
2014	-0.04%	-2.96%	76.27%	71.58%

As you can see, after 7+ years we are up 71.6% versus the R3K being up 76.3%. Sure does not seem worth the effort.  Of the 7 full years, MFI has won 4 and lost 3. 2007 and 2011 were the years that really hurt.

Thinking first about those years, then I will dig a bit, in 2007 smaller cap stocks really under-performed the broader index.  And my MFI index, which goes down to $100m market cap, was overweight in that area. In 2011 (and 2012 to a lesser extent) there was a largish proportion of for profit education, home healthcare and Chinese Reverse merger stocks.  These all got hit hard and drug on the MFI index.  Of course JG comments that there will be some stocks with "hair on them" and that is why you need more of a portfolio approach and why some years will do poorly.

Sub Components That Have Done Well

I have done work in the past (MFI Diary: White Lies, Lies and Statistics) that gives a lot of thought to components that have done well.  The table below shows average annual gains for MFI stocks by market cap decile:

MC Decile	Avg Pct Chg	Count
1	15.3%	471
2	12.3%	473
3	16.5%	472
4	16.1%	470
5	6.3%	473
6	6.9%	472
7	7.2%	471
8	7.5%	472
9	5.5%	473
10	2.2%	570

Pretty much night and day. The 4 largest deciles of market caps (which roughly equates to $1b or greater) have done very well.  Obviously, 15% per year over 7+ years is a very satisfactory return.  Actually I just noticed that the table has too many stocks in bottom decile.  Here is the fix.  makes no difference materially in my commentary:

MC Decile	Avg Pct Chg	Count
1	15.7%	481
2	12.7%	482
3	15.3%	483
4	16.1%	481
5	6.3%	481
6	5.9%	484
7	9.0%	481
8	6.6%	483
9	3.3%	480
10	4.4%	481

I think when you get to $1b and greater, you ended up avoiding many of the issues I discussed above, the fact that small stocks really struggled in 2007 and problematic stocks such as Chinese Reverse mergers were beneath the $1b threshhold.

Stocks with larger dividend rates (2.6% and above) have also fared very well.  Perhaps there is something about these that makes it more likely they will have decent earnings due to comfort of management offering a dividend, or perhaps it is because many of the problem stocks mentioned above: smaller cap, Reverse merger Chinese, For profit education and home healthcare did not have a sizable dividend.

Yield	Avg Pct Chg	Count
Under 2.6%	9.1%	1,739
2.6% and higher	21.0%	707
Grand Total	12.6%	2,446

Note this table does not go all the way back to the beginning as I did not capture yield for the first 4 years.

Lessons?

There is probably something inherently "safer" in going with larger market cap stocks from the lists, and perhaps even those that offer a dividend.  It seems to make sense, even if JG did not explicitly say so in his book.  But one could also argue that 7+ years is not a long enough test period and that there will be reversion to the mean, where smaller cap stocks do better.  I have not run the numbers, but I would not be surprised to see since 1/1/12 that under $1b has done pretty well.