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My Search for the Worst Mutual Fund Yielded a Surprising Result

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I wanted find the worst performing actively managed Large Cap Blend style mutual fund in Morningstar’s data base over the five year period ended October 31, 2012.

English: Legg Mason Tower, Legg Mason Headquaters

I was surprised to find that the fund was Legg Mason Value Trust which until earlier this year had been managed by legendary fund manager Bill Miller.  The fund has several share classes, for this analysis I used the I share class (ticker LMNVX).

Bill Miller is a legendary fund manager because he was able to beat the return of the S&P 500 Index each year over a 15 year stretch from 1991-2005.  This is an incredible feat of performance and consistency.

How did this fund end up at the bottom of the rankings?  Starting with 2006, the fund underperformed the index each year except 2009.  Let’s look at the fund’s performance over the past 10 + years:

Year Fund Return S&P 500 Return Category Avg. Return Fund Rank in Category
2002

-18.06%

-22.10%

-22.25%

13

2003

44.99%

28.68%

27.05%

1

2004

13.09%

10.88%

10.02%

14

2005

6.36%

4.91%

5.88%

40

2006

6.92%

15.79%

14.17%

98

2007

-5.73%

5.49%

6.16%

98

2008

-54.61%

-37.00

-37.39%

99

2009

41.96%

26.46%

28.17%

6

2010

7.71%

15.06%

14.01%

96

2011

-2.99%

2.11%

-1.27%

70

2012 YTD

7.72%

10.29%

8.86%

71

Via Morningstar as of 11/16/2012

In terms of category rank, 1 is the top of the category, 100 would equal the bottom.  This fund ranks in the 99th percentile of the Large Blend category for the five years ended October 31, 2012 (there was actually one fund ranked lower but it was a bit of a specialty fund so I eliminated it).

What happened to Legg Mason Value Trust?

What happened to this high flier?  While I’ve never invested either my own money or any client money in this fund, here are a couple thoughts:

The fund’s assets peaked at just under $7 billion in 2006, fund assets stood at about $328 million as of October of this year.  I’m guessing that as performance continued to slide, investors continued to redeem their shares.  The need for liquidity to meet these redemptions has most certainly been a drag on the fund’s performance.

In 2002 the S&P 500 lost over 22%; the fund was able to limit its loss to just over 18%.  In 2008 the S&P 500 lost 37% while the fund lost an astonishing 54.61%!  That means that an investor with $10,000 in the fund on January 1, 2008 saw their holdings drop to $4,539 by the end of 2008.  The value-oriented approach that had served shareholders well over the years was in the process of producing a third straight year of the fund performing in the category’s bottom 2%.

Lessons in Picking a Mutual Fund

Many argue that no active fund manager can continually outperform the markets over time.  The performance of this fund gives weight to that argument.  I will leave this discussion to others, but there are several lessons to be learned here:

  • Every market environment is different.  During the market decline of 2000-2002 there were still a number of mutual funds and market sectors that held up pretty well.  During the sharp decline of 2008-09 pretty much no strategy worked well.  Funds such as Dodge & Cox Stock which had been stars in the 2000-2002 timeframe saw their strategy backfire and sustained out-sized losses for their shareholders.
  • A precipitous decline in assets often becomes a snowball.  In the case of Legg Mason Value Trust fund assets declined from just over $6 billion at the end of 2007 to about $1.35 billion at the end of 2008.  This is a greater drop than can be accounted for by the fund’s investment losses.  The level of redemptions served to amplify to fund’s losses.  This issue has continued through the present and has limited the fund’s ability to take advantage of the market rally since March of 2009.
  • It’s hard for superstar funds and managers to outperform forever.  Fidelity Magellan and American Funds Growth are two examples.  On the flip side the managers at Fidelity Contra and Fidelity Low-Priced Stock have continued to be top performers over long periods of time and in the face of significant asset growth in their funds.  They are the exception rather than the rule.

Evaluating an actively managed mutual fund is not an easy task, which is another argument for index products.  Many actively managed funds are not worth the extra expense ratios they charge.  This is not to say that there are not some excellent actively managed funds that are worth investing in.  Just be prepared to understand why these funds have been successful and to monitor them for changes in key personnel, major fluctuations (up and down) in the level of fund assets, changes in the fund’s investment process, and organizational changes that might impact the investment process among other factors.

Please feel free to contact me with your financial planning and investment questions.

Check out Morningstar.com to analyze your mutual funds and to get a free trial for their premium services.

Photo credit:  Wikipedia

 

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Comments

  1. Ornella @ Moneylicious says:

    It is hard for a fund to keep up with their own liquidity requirements when shareholders are redeeming. Even so, there seems to be more reason why the fund performed poorly. After a while ( this varies) funds revert back to their mean. While I agree with you that there are active funds performing well, most people don’t have the time or knowledge ( even if they did have the knowledge ) to find those funds and justify the expense. This was a good write up! Your clients are lucky to have you!

    • Roger Wohlner says:

      Thanks for the comment and the kind words Ornella. I agree with your comments that there were certainly other reasons the fund’s performance fell off including reversion to the mean. Very few active managers can stay on top for 15 or 20 years or more.

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