Objective information about financial planning, investments, and retirement plans

Pens, Trinkets, and Mutual Funds

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McCormick Place

With the annual Morningstar Investment Conference coming up here in Chicago next week, my thoughts naturally gravitate to replenishing my office supply of high quality pens in the exhibit hall at McCormick Place.  Truth be known, my thoughts are more focused on preparing for my participation on a panel on Friday morning called Practical Solutions for a Challenging Retirement Landscape.  Morningstar’s superstar financial author and columnist Christine Benz was kind enough to invite me to participate in this discussion along with representatives from T. Rowe Price and Vanguard.

Pens and Trinkets

Ever since the first financial conference I attended in the mid 1990s I’ve never ceased to be amazed by the number of items that mutual fund providers and other financial services vendors can find to stick their names and logos on.  When my kids were younger they were the only ones in their school with backpacks from places like the Philadelphia Commodity Exchange and the London Stock Exchange.

At one point I had a whole section of T-shirts from defunct mutual fund companies like Strong and Berger.  Add an infinite number of logoed tote bags and baseball hats and you get the picture.  Our kids always liked the stress balls I found at many of the booths (we were obviously tough parents).

In recent years I’ve tried to be more practical at Morningstar and other conferences and focus on gathering a supply of pens for the office.  I always grab as many as I can because my wife and kids always seem to be on the prowl for these as well.

While strolling around the exhibit hall at last year’s conference I was really making a great haul on pens when it suddenly hit me:  There are a lot of companies that offer mutual funds and I’ve never heard of many of them.  And I’m a financial advisor.

How many mutual funds are there? 

According to the Investment Company Institute there were 7,596 mutual funds at the end of 2012.  This is down from the high of 8,305 at the end of 2001.  Add in 602 closed-end funds and 1,194 ETFs and there are lots of choices for investors.

How do you choose the right funds? 

Any selection of mutual funds, ETFs, or any other investment vehicle should start with an investment plan, which is ideally an outgrowth of your financial plan.  Once you have an asset allocation strategy you will want to fill these allocation buckets with funds and ETFs that are appropriate for your situation.

Here are six mutual fund selection mistakes to avoid:

  • Assuming that a “brand name” fund from a well-known fund family is automatically a good investment choice.
  • Relying on lists of top mutual funds from popular magazines or websites.
  • Ignoring a fund’s history.
  • Avoid mutual funds from fund issuers that you’ve never heard of.
  • Assume that all index funds are created equally.
  • Assume that mutual fund companies automatically have your best interests at heart.

Some additional considerations in selecting mutual funds and ETFs:

  • Expenses matter.
  • When using an index product make sure that you understand what index the fund is tracking and that it tracks that index closely.
  • Avoid actively managed funds that are nothing more than closet indexers.
  • When building a portfolio understand the concepts of diversification and correlation.
  • Understand why you are choosing a given fund or ETF, where it fits in your portfolio, and what would cause you to eliminate this holding.

The Morningstar Investment Conference is a great place to catch some excellent educational sessions and to talk to fund and ETFs issuers to learn about their products.  I would be remiss in not mentioning the great work done by Leslie Marshall and her team from Morningstar in staging this conference.  The fact that it always runs smoothly is a tribute to Leslie’s organizational and management skills.

Please feel free to contact me with your investing and financial planning questions.  Check out our Financial Planning and Investment Advice for Individuals page to learn more about our services.   

For you do-it-yourselfers, check out Morningstar.com to analyze your mutual funds and ETFs and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.  

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Investing: Even Indexing Takes Work

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INDEX IIM Lucknow Logo

The benefits of low-cost index mutual funds and ETFs are all over the news.  They were front and center in the recent PBS Frontline Special The Retirement Gamble.  Index funds are a great tool for investors of all ages; in many cases these passively managed funds beat the majority of their actively managed peers within the same investment style.  However, investing in index funds takes work, especially with the proliferation of new index products that continue to hit the marketplace.

Expenses matter 

Costs matter when investing.  One of the biggest lures of index fund investing is that many of these products provide a low cost way to investment in a given segment of the market.  If you are looking for an index fund that mimics the S&P 500 there are many great low cost alternatives such as the Vanguard 500 Index Fund (Ticker VFINX) with an expense ratio of 0.17% or the SPDR S&P 500 Index ETF (Ticker SPY) with an expense ratio of 0.09%.  On the other hand, there is also the Rydex S&P 500 A (Ticker RYSOX) with its expense ratio of 1.51%.  How big of a deal is this difference?

A $10,000 investment in the Vanguard 500 fund made on May 31, 2006 and held until May 15, 2013 would now be worth $15,064.  That same investment in the Rydex S&P 500 fund would be worth $13,798 or 9.2% less for an investment in a mutual fund tracking the same index as the Vanguard fund. 

Understand the underlying index 

In the wake of the 2008-2009 market downturn new index products, especially in the ETF space, have proliferated.  ETF providers are falling all over themselves to bring new index products to the market hoping to attract assets.  Like any investment, investing in an index fund or ETF requires that you understand what it is that you are buying.

When I think of indexing I think of the traditional, basic index products that track benchmarks such as the S&P 500, the total U.S. stock market, the total non-U.S. market, the domestic bond market, etc.  Additionally I typically use index funds to benchmark the U.S. small and mid cap equity spaces, real estate, and emerging markets equity among others.

Several months ago Market Watch’s Chuck Jaffe cited a Vanguard report that found “1,400 U.S. listed ETFs track more than 1,000 different indexes. But more than half of these benchmarks had existed for less than six months before an ETF came along to track it.”  

As an investor this should be a huge red flag.  What this study says is that many of these new index products were developed much like the monster in the Mel Brook’s classic Young Frankenstein.  Look back-testing is not inherently bad and many of these new index products are appropriate for professional traders.  However if you are looking to index in the fashion that Vanguard founder John Bogle and others espouse then you should consider sticking with index products that track known, battle-tested market benchmarks.

Asset allocation is still vital 

Whether you use index products as a portion of your overall portfolio in conjunction with other investment vehicles such as actively managed mutual funds or individual stocks, or if you invest in index funds exclusively you still need to develop and asset allocation for your portfolio.  As I say frequently on this blog, this should be done as an outgrowth of your financial plan.

Even a seemingly simple strategy of investing in a total U.S. stock market fund, a total international stock market fund, and a total bond market fund still requires that you determine how much to invest in each fund, that you monitor your allocation and rebalance when needed, and that you review and adjust your target allocation as you age or if your situation changes.

Index funds and ETFs are a great investment tool.  Like any tool it is important that you select the right index product and that you manage your portfolio properly.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out the Hire Me tab to learn more about my freelance financial writing and financial consulting services.  

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Do Index Funds Reduce Investment Risk?

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Index mutual funds and ETFs (we will refer to them as index funds unless otherwise indicated going forward in this article) have received a lot of favorable press of late.  This is justifiable as index funds offer a low cost way to invest and are generally quite specific to a given investment style.  Over the years I have been asked if index funds reduce investment risk.  Let’s examine this question.

Illustration of Standard deviation

What is investment risk? 

One definition of  investment risk as the variability of the investment’s returns also known as standard deviation.   Note variability means returns that are both higher and lower than the fund’s average returns over a given period, say the trailing three or five years.

I contend that most investors would define investment risk as the risk of losing money on an investment.  This is especially true in the wake of the recent financial crises.

An index fund takes on the risk of the underlying index it tries to replicate. For instance, in 2008 the S&P 500 Index lost 37 percent. There are many funds and ETFs that track that index. They all lost around 37 percent plus the fund’s expenses. For example, the Vanguard 500 Index Fund (symbol VFINX) posted a loss of 37.02 percent for the year.

Active management vs. index funds 

Let’s take a look at several of Morningstar’s analyst favorites in the Large Growth style compared with an index fund in this style and with the S&P 500 index.

10 yr. Standard Deviation

10 yr. mean return

Vanguard Growth Index (VIGRX)

+/-15.14%

8.10%

Jensen Quality Growth (JENSX)

+/-13.19%

6.62%

Vanguard Primecap (VPMCX)

+/-15.50%

10.83%

Harbor Capital Apprec. (HACAX)

+/-15.57%

8.65%

S&P 500 Index

+/-14.80%

7.93%

Data from Morningstar.com

In plain English, the Vanguard Primecap fund posted an average annual return of 10.83% over the trailing ten years depicted.  Based on fund’s standard deviation of +/- 15.50% one would expect the fund’s returns to range between -4.67% and +26.33% about 68% of the time.

The bigger take away from this chart is that the Vanguard Index fund’s volatility was lower than a couple of the funds and higher than Jensen.   As with any index fund the Vanguard fund experienced approximately the level of risk and return of its underlying index, other actively managed funds in this category experienced more or less risk and return based upon the stock selections of the managers.

Manager Risk 

Index funds can eliminate manager risk, or the risk of investing in an actively managed fund only to see the manager underperform the benchmark index.  As an example for the trailing periods ending January 31, 2013 the Vanguard Growth Index outperformed 83% of the other Large Growth funds for the trailing three years; 84% of the other fund for the trailing five years; and 61% of the other fund for the trailing ten years.

This is not to say this will be the case with all index funds over all periods of time. However, a well-run index fund should track its underlying index closely and deliver index-like performance.

Several years ago an instructor at a continuing education session indicated that many of the actively managed mutual funds atop the 10-year rankings in their respective categories most likely spent three of those calendar years in the bottom quartile of their category rankings. For an investor who held one of these funds over that entire 10-year period this isn’t a problem. But investors who bought into such a fund at a different time or over various periods of time may have had quite a different experience.  As we know, money tends to chase performance, hot funds attract investor dollars, funds that are struggling tend to see more client redemptions.  This is so prevalent that Morningstar measures investor performance along with the actual performance of the mutual fund.  Investor performance provides a measure of how actual investors fared by investing in this fund, including the timing of investments and redemptions.  In many cases investor performance varies significantly from the actual fund returns.

A few other points to consider: 

Expenses matter

You should generally buy the cheapest index fund that tracks the index you are interested in. There is a huge disparity in the fees for funds that track the S&P 500 for example.

Understand the underlying index.

There has been a proliferation of new index ETFs tracking a variety of indexes. In many cases I have never heard of many of these indexes. Make sure the index tracked by the fund or ETF you are considering makes sense for your overall portfolio and that the index has a real history not just some back-tested data behind it.

Using index funds is no guarantee of investment success

Just like with any mutual fund or ETF, how you use these products is the key to your success. Index funds are nothing more than a building block to construct your portfolio.

Don’t dismiss active managers  

Evaluate actively managed funds and understand why they have been successful in the past and in what types of environments they might lag their peers. Moreover, carefully think through the role the fund might play in your portfolio, and be aware of who is managing the fund. Is the same person or team that actually compiled the impressive track record still in charge? Or has this manager moved on, placing the fund in the hands of some new, unproven manager?

Index funds do not necessarily reduce investment risk or guarantee a higher investment return than using actively managed funds.  Like anything in the investment world, investing with a strategy (ideally tied to your financial plan), monitoring your results, rebalancing your allocation, and making adjustments to your portfolio when warranted are still key elements in successful investing.  Index funds are simply a tool you can use in this process.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.  

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Mutual Funds and Alabama Football – Does Past Performance Matter?

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As most of you know, The University of Alabama is once again the king of the college football world.  They recently vanquished Notre Dame to win their second consecutive BSC Championship and their third in the past four years.  Including a BCS title while coaching LSU, Alabama coach Nick Saban has won four BCS titles in the last eight years.

Can we infer anything about the future from this performance? I would argue yes based upon a couple of recent articles that I have read about Saban’s approach to coaching and managing the football program.  According to the articles, there is a process in place for just about every aspect of the program from recruiting to practices and so on.  While Alabama still has to go out and play the games (in arguably the toughest conference around) they generally seem to find a way to win under Saban as evidenced by his worst record of 10-3 in 2010.

A repeatable process is what sets Saban apart and in my opinion is the key factor in his coaching success.  A repeatable process is also a key element in investment success.

Clearly in the investment world a disclaimer on the order of “…past performance is no guarantee of future performance…” is often used.  And with good reason.  If we apply this to the world of mutual funds any number of factors can come into play.  I and many other advisor colleagues and self-directed investors have migrated in large part to passive, low cost index funds and ETFs simply because so few active managers deliver top returns year in and year out.

Two active mutual funds managers who consistently deliver superior performance 

Sequoia SEQUX is a large cap blend fund that started as disciples of Warren Buffet’s investing style and still has a very definite process in place for finding stocks that meet the management team’s criteria.  Over the 15 years ended 12/31/12 the fund ranked in the top 5% of its category and has beaten the return of the S&P 500 by an average of 308 basis points annually.  The fund ranks in the top 2% for the trailing 3 and 5 year periods and the top 22% for the trailing 10 years.  Moreover this fund is closed to new investors more than it isn’t the fund was closed for 25 years until 2008.  At that point I added this fund to the portfolios of a number of clients.  The fund closed again at the beginning of 2012.  This is a sign of a superior fund company in that they didn’t feel they can invest all of the new money that was flowing into the fund so they closed it.

PIMco Total Return PTTRX is an Intermediate Bond Fund run by famed bond fund manager Bill Gross.  This is the largest and one of the most successful bond funds around.  Gross is very visible in large part due to his regular appearances on CNBC.  Many thought he had lost his touch in 2011 when the fund ranked in the bottom 13% of its category; however the fund turned around and finished in the top 12% for 2012.  The fund ranks in the top 25% for the trailing 3 years ended 12/31/12; the 7% for both the trailing 5 and 10 year periods and the top 3% of its category for the trailing 15 years.  In all cases the fund has outperformed its benchmark the Barclay’s Aggregate Bond Index significantly.  Gross and the PIMco team clearly have a process in place that has been successful and this was reinforced by the success of the recently introduced ETF version of the fund.  I have client money in this fund.

Two active managers who used to deliver consistently superior performance

American Funds Growth AGTHX was at one time a preeminent large growth fund.  While fund had a very strong year in 2012, returning 20.54% and outpacing the S&P 500 by 454 basis points, the fund ranked in the bottom half of its category in 3 of the 5 calendar years from 2007 -2011.  This was after a five year run during which the fund had ranked in the top 18% or better of its category in each of those five years.  I suspect the fund’s bloated size followed by significant reduction in fund assets via withdrawals contributed to this recent mediocre run.

Legg Mason Capital Management Value Trust LMVTX was formerly managed by the legendary Bill Miller who had rattled off a string of 15 consecutive years of beating the fund’s benchmark the S&P 500 Index.  In recent years the fund has fallen off  to the point where the fund ranked in the 99th percentile for the 5 years ended 12/31/12 and the absolute bottom of it category for the trailing 10 years.

The point is that there are actively managed mutual funds who deliver consistently excellent performance.  Even here, the performance can be uneven as evidenced by the fact that Sequoia has ranked near the bottom of its category in several individual years over the course of its solid run.

I tend to use index funds and ETFs pretty extensively, but I still use a fair number of actively managed funds as well.  Finding funds that fit the needs of my clients takes work and ongoing monitoring, but I have found this to be worth the time spent.  Even with the best managers there are no guarantees about the future, but analyzing and understanding the details of their past performance can provide insight.

As for the Crimson Tide, they may not win a third straight national title, they might not even win their division of the SEC (LSU and Texas A&M are formidable obstacles) but I have no doubt that they will be in the mix in 2013 and as long as Saban is coaching due to his process and preparation.

Please feel free to contact me with questions about your mutual funds or to address your investment and financial planning advice needs. 

Do-it-yourselfers check out morningstar.com to analyze your investments and to get a free trial for their premium services. Check out our Resources page for links to a variety of tools and services that might be beneficial to you.

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Mutual Funds – The First Shall be Last and So On

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Well another year is in the books and there is no shortage of articles about what worked well and what didn’t in terms of investing.  For those of us who use and follow mutual funds it’s always instructive and interesting to take a look back as we move forward.  Here are some observations and examples from 2012 and some lessons that we can take into the future.

Artisan Mid Cap Value ARTQX 

The managers of this fund were named as Morningstar’s Domestic Manager of the Year for 2011.  So how’d they do in 2012?  The fund gained a respectable 11.39% for the year, but that only ranked the fund in the 86th percentile (bottom 14%) of its category.  Did the award go to their heads?  I doubt it.  I’ve written about this closed fund here before and it is one of my favorite mutual funds.  This fund is included in the menu of several 401(k) plans for whom I provide advice as well as in the portfolios of many of my individual clients.  The fund’s track record since its inception has been exemplary and in fact the fund ranks in the top 1% of all funds in its category for the ten years ending 12/31/12.  Artisan is a solid fund company who regularly closes funds that have become too large, including this fund.  While we can’t predict the future, the fund’s relatively poor 2012 performance is a non-issue in my mind at this point.

American Funds Growth AGTHX

My October post on this multi-share class fund asked if it was a fallen star.  Using data from the A shares, the fund had a banner 2012 returning 20.54% and placing in the 7th percentile of its category.  This comes after finishing in the 64th percentile or below in three of the five prior calendar years.   This still leaves the fund in the 53rd percentile of its category for the five years ended 12/31/12; though the fund is in the 22nd percentile for the trailing ten years.  As I discussed in the post, the fund was a top performer year in and year out until 2007.  As one industry publication pointed out, the fund has become somewhat of a “closet indexer” with its increasing correlation to the S&P 500 Index.  In fact the Vanguard Large Growth Index Fund is a far less expensive alternative that has outperformed Growth Fund by almost 300 basis points annually for the past three years and has gained almost three times as much annually for the past five years ending 12/31/12.  While I have tremendous respect for the American Funds as a group, this fund’s 2012 performance does nothing to change my view of the fund as an investment vehicle for my clients.

On a more macro level, 2012 saw the rebound of both developed and emerging markets international funds as a group after a dismal year in 2011.

What does all of this tell us, frankly not much as far as how to invest into the future

 An investment process is critical

Here are some of the factors that we usually look at when evaluating mutual funds and ETFs (from Fi360 and our Investment Policy Statements):

  • Does the fund have at least a three year track record?
  • Does the fund manager have at least a two year track record with the fund?
  • Does the fund have at least $75 million in assets?
  • Do the fund’s composition (its holdings) and its Morningstar style look like other funds in its investment category?
  • The fund’s expense ratio should be in the category’s 75th percentile.  (In reality we like to see this number much lower than that).
  • The fund’s risk-adjusted returns (Sharpe and Alpha) in the top 50% of its peer group of funds.
  • Trailing 1, 3, and 5 year returns at least in the top half of its peer group of funds.
  • Has the fund experienced a significant gain or loss in assets?
  • Has ownership of the fund changed?
  • Has there been turnover in the fund’s management?

While some investors may disagree, we believe in asset allocation and portfolio rebalancing.  We use both active and passive mutual funds and ETFs to fill the allocation slots in the portfolio, and we monitor those holdings on a regular basis.

As discussed above, there will always be fluctuations in the performance of various investments whether they are individual stocks or bonds or managed products such as mutual funds and ETFs.  Certain asset classes will underperform at various times (such as Foreign Stocks in 2011).  The point is to have an investment process in place that uses a disciplined methodology to make investment decisions.  In my experience, this is a key element in long-term investment success.

Feel free to contact me with questions about your investments.

For you do-it-yourselfers, check out Morningstar.com to analyze your investments and to get a free trial for their premium services.  Please check out our Resources page for links to some additional tools and services that might be beneficial to you.

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Are Mutual Fund Closures a Bad Thing?

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Road closed, farm road in Champaign County, Il...

You’ve been following a mutual fund for awhile and you’ve decided that this fund is a good fit for your portfolio.  You go online to make an initial purchase and you learn the fund has closed to new investments.  While you might be frustrated, overall I tend to view fund closures as a positive move in most cases.

Factors that might lead to a fund closing 

Typically the main reason that mutual funds close to new investments is that more money is coming in than the managers feel they can effectively invest.  Closely related to this is the rule that funds are only allowed to buy into the stock of a single company if that holding is 5% or less of the total value of the fund.  (Note a holding may constitute more than 5% of a fund’s value due to price appreciation).  Generally fund closures occur in actively managed mutual funds versus passively managed index products.

Fund closures benefit existing shareholders 

In my opinion, a fund closure is generally a sign of a fund company that values its shareholders.  A case in point is Artisan, a fund company based in Milwaukee.  Over the years I have used Artisan Mid Cap Value (ARTQX) extensively in several of the retirement plans for whom I serve as advisor as well in the portfolios of many of my individual clients.  The management team of this fund was named Domestic Manager of the Year for 2011 by Morningstar.

Artisan runs 12 funds, of which 5 are currently closed to new investors, including Mid Cap Value.  Even with the closure, fund assets have topped $8 billion a high for the fund.  The fund’s performance has lagged in 2011, though I don’t think that it is related to the increased size.  The fund ranks in the top 1% of all Mid Cap Value funds over the past 10 years.

The fact that Artisan is willing to close a popular fund like Mid Cap Value speaks volumes about the firm.  Shutting off the spigot of new money means that the firm will lose the fees it would collect on these assets.  Artisan is also in the process of going public.

Examples of large funds that didn’t close 

This can work both ways.  An example of a fund that in my opinion should have closed to new investment is Ariel (ARGFX).  This was an outstanding Small Cap Value fund run by John Rogers, a well-known Chicago-based value investor.  Fund assets ballooned from about $600 million in 2001 to over $4.7 billion in 2005.  The fund never closed its doors to new money and was forced to increase the market cap of the stocks held in the fund.

As a Mid Cap Blend fund, performance has largely been below average, the fund ranks in the middle of the pack for the trailing 5 years and in the bottom 25% of its category for the tailing 10 years.  Performance has picked up in recent years with the fund ranking in the top quarter of its category in 2009, 2010, and year to date in 2012.  In-between the fund ranked in the bottom 7% of its category in 2011.  This improved performance follows a significant decline in fund assets in recent years.

I haven’t followed this fund for several years and have no client money invested here.  Would shareholders have been better served had the fund closed its doors a number of years ago and stuck to the type of investing it was known for?  In my opinion yes, but I’ll leave that to others to decide.

On the flip side of this is Fidelity Contra (FCNTX).  Will Danoff manages about $85 billion in this fund and over $100 billion in this style (Large Growth) when you add in some other portfolios under his management.  The fund has placed in the category’s top 39% or better in every annual period since 2002 with the exception of 2009 (when the fund earned over 29%).  For the trailing 10 years the fund ranks in the category’s top 7%.  To be able to manage this much money as well as Danoff has year in and year out is a commendable and rare feat.

Asset bloat

While asset bloat can be a problem in any fund, it is generally a more serious issue in a fund that invests in small or mid cap stocks.  At some point there are only so many good places to invest new cash coming in.

While fund companies are in the business to make money, my experience has been that the fund companies that tend to close funds when they get too big also tend to run funds that are better performers over time.  At some point if a fund gets too big it might also become a “closet indexer.”  In those situations, why pay the fees associated with an actively managed fund?  Why not just buy an index fund or ETF?

What if my fund closes? 

Typically if you already own a fund and it closes, you be able to buy more shares if you wish.  This is not always the case, however.

If a fund that you were considering closes before you own it, look for an alternative fund.  This might be a good opportunity to consider a low cost index fund or ETF in the same asset class.

Feel free to contact me with questions about your investments.

For you do-it-yourselfers, check out Morningstar.com to analyze your investments and to get a free trial for their premium services.

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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.

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Mutual Funds – B Shares are a Dumb Ox

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I’m guessing that our family is no different from most in that we have some unique ways of communicating.  For example, beef tenderloin was a dish that my wife would make on a number of special occasions as the kids were growing up.  She cooked it in a black roasting pan with white specs, hence beef tenderloin is forever know as “polka dot pot meat” in the Wohlner house (the black roasting pan is long gone).

 English: Oxen in Marine Drive, Mumbai, India.

In this same vein, the word oxymoron has been changed to “Dumb Ox” in Wohlner speak.

Several years ago I was having lunch with a CPA who was also licensed as Broker Dealer and sold securities including loaded mutual funds to some of the firm’s clients.  I’ve never understood how a trusted advisor like a CPA could turn around and sell financial products for a commission, but that is for another post.  Over lunch the CPA said “… I know that you will disagree, but I often think there is nothing better for many clients than a good B Share…”   He’s right I do disagree, to me a “Good B Share” is the ultimate “Dumb Ox” (no offense to any Oxen intended).

Share Class Comparisons

In the world of commission and fee-based financial product sellers, one way for these brokers and registered reps to be compensated is via commissions from selling mutual funds.  The main share classes where this occurs are A, B, and C Shares.  Using the American Funds Growth Fund as an example let’s take a look at the differences in these three share classes:

Share Class Ticker Front Load Deferred Load Expense Ratio 12b-1 fee
A AGTHX 5.75% 0% 0.71% 0.24%
B AGRBX 0% 5.00% 1.46% 1.00%
C GFACX 0% 1.00% 1.49% 1.00%

Source:  Morningstar.com

The American Funds, like an increasing number of fund companies no longer sells B share mutual funds.  However, even if there are no new B shares being sold; many investors are still trapped in the overpriced funds by the surrender charges.

With the A shares, a $10,000 investment would incur an upfront sales charge of $575, meaning that $9,425 would be invested in your account.

The No Front Load Option – B Shares

As an alternative for investors who didn’t want to pay the upfront sales charge B shares were created.  While there is no upfront sales charge and the entire $10,000 is invested, the ongoing expenses of the fund are considerably higher.  Additionally you are literally trapped in the fund by the deferred sales charge which starts at 5% and declines by 1% each year until it goes away altogether in year 6.  While you can generally exchange your fund for another B share fund in the same fund family, you will get hit with the surrender charge should you sell any or all of the shares.  At the end of the surrender period the B shares are supposed to revert to the less expensive A shares.  I’ve heard of instances where B shares were not automatically moved to the A shares, it is always a good idea to read your brokerage statements.

What if I still own B shares?

If you hold B shares of any fund family I suggest the following:

  • If your fund has moved out of the surrender period and has not moved to the less expensive A shares call your financial advisor and ask why.
  • If your fund is still in the surrender period do a cost/benefit analysis to determine if moving out of the fund and buying into a less expensive (and presumably better performing) alternative would be cost effective.  Basically you want to look at the difference in the annual expenses of the B share fund vs. the alternative and determine how long it would take you to breakeven after incurring the surrender charges based on the cost savings.
  • Consider firing the financial advisor and the firm that put you into the B share in the first place.  I’ve been in this business a long time and I can’t see any reason to have put a client into a B share except greed (though I’m open to listening to other explanations).  The ongoing payments to the brokerage firm (the 12b-1 portion of the expense ratio) and the “handcuffs” placed on shareholders by the surrender charges are quite lucrative for the broker, and serve to reduce your returns.  At the very least confront the advisor and ask them why you were sold a B share in the first place.
  • I’m biased on this subject and in the interest of full disclosure I am a fee-only financial advisor and I do not accept commissions or sales loads of any kind.

As always, be sure that you understand ALL expenses and fees that you will be paying when working with a financial advisor.  What you don’t know can really reduce your investment returns.

Please contact me with any thoughts or suggestions about anything you’ve read here at The Chicago Financial Planner. Don’t miss any future posts, please subscribe via email. Please check out our resources page as well.  

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Does it Matter Who’s Managing Your Mutual Fund?

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One of the analytical tools that I use in my practice is the fi360 Toolkit.  They rank mutual funds and ETFs on 11 criteria, one of which is the tenure of the fund manager.  In order to receive a top ranking here, the manager must have tenure of at least 2 years.  We generally use 3 years in our Investment Policy Statements.

Does this mean that you should dump a fund if you learn that the manager is leaving?  Not necessarily.

The Vanguard Example

As an example, for many years Gus Sauter was responsible for the management of most of Vanguard’s index funds.  Several years ago he stepped out of the day-to-day management of the funds into the role of the firm’s Chief Investment Officer.  In my opinion, Vanguard’s index products have not missed a beat.

Mr. Sauter is retiring at year-end after the transition to a new index provider for a number of their funds.  On both counts I suspect Vanguard will again not miss a beat.  Why?  People are a critical part of the investment management process.  But so is the process.  Based upon my experience Vanguard has both in place.

Fund manager changes – done well and not so well

In another example, I have used Columbia Acorn International Z fund for a number of years in some client portfolios.  It is an actively managed small/mid cap foreign equity fund.  The fund had been managed by legendary manager Ralph Wanger, he was then joined by his wife (an outstanding fund manager herself) Leah Zell; Zell then was the sole lead manager until May of 2003 after Wanger’s departure.  She was succeeded at the fund by her two top underlings.  I had notified my clients of the change and suggested a wait and see approach.  This was a wise move as the fund has continued to perform well and also to perform within my expectations for the fund.  Again an example of having solid people in place (including depth) and having a solid investment process in place.

Perhaps the ultimate example of the other side of this coin is the soon to be shuttered Janus Worldwide fund.  Janus was one of the hottest mutual fund shops of the 1990s Dot Com boom in the markets.  The fund was very ably managed by Helen Young Hayes and at its peak had over $44 billion in assets.  The fund was a top performer until the bear market of 2000-02 when the fund’s performance really sagged.  Hayes left the fund in 2003; there have been several managers since, in many ways mirroring the revolving door in the executive suite (five CEOs since 2003).  None of these mangers subsequent to Hayes have been able to duplicate the fund’s past performance, the fund ranks in the bottom 3% of its peer group for the past 10 years.  The fund is scheduled to be merged with another Janus fund shortly.

It does matter who is managing your mutual fund, but beyond that it is important that the fund have a strong investment process in place.  While the fund’s management might seem to be more important for an actively managed fund, in reality proper management of a passive index fund is just as important.

Please feel free to contact me for a review of your investments. 

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Mutual Funds – Are “Family Values” Important?

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My Investments from the last year or so

Over the years I’ve been asked whether there is a mutual fund family (or families) that I prefer.  My answer is generally along the lines that I choose mutual funds and ETFs based on screening and their fit in a particular client portfolio.  This is absolutely true but there are families that I do tend to use more than others.

For example, for the individual client assets which I custody at Schwab (which is the bulk of them):

  • Vanguard mutual funds and ETFs comprise about 22% of these assets.
  • PIMco mutual funds, ETFs, and closed end funds make up just over 10%.

In addition to Schwab I have individual clients with a smattering of assets at other custodians, including Vanguard.

A significant portion of my practice involves providing advice to several 401(k) plans, as well as a couple good-sized pension plans and foundations.  Both Vanguard and PIMco are well-represented, along with Fidelity.  In the case of Fidelity two of the larger 401(k) plans are administered by Fidelity and we do have a number of Fidelity funds in both plans (along with a number of non-Fidelity funds).

In the case of Vanguard I am drawn to their low cost index products, I rarely use their actively managed funds.  In the case of PIMco the bulk of the assets are in three of their funds. Their fixed income expertise and their research orientation are impressive.

A Sample 401(k) Menu

Beyond this a look at the funds and ETFs that I use would reveal no particular loyalty to any family or fund provider.  I am typically looking for something in a particular fund in a given asset class and I don’t really care which fund family they are affiliated with, unless I uncover some negative aspect about the fund company.  As an example, here are the fund families represented in one of the 401(k) plans for which I serve as advisor:

  • Vanguard (4 index funds plus their Target Date Funds)
  • American Funds
  • American Beacon
  • PRIMECAP
  • Artisan
  • BMO Funds
  • Northern Funds
  • Dodge and Cox
  • Oakmark

Red Flags to Look For

While I am fund family agnostic, there are however, some fund family red flags that might give you pause when considering an investment.  Here are three:

  • A sense of general turmoil.  Janus is a prime example of firm where this concern is prevalent to me.  The company is on its 5th CEO since 2003 and they have experienced a noticeable amount of manger turnover.
  • Refusal to close popular funds.  One of the things that I really like about Artisan (a relatively small fund firm in Milwaukee) is that they routinely close funds when they take on too much money for the managers to effectively manage.  Perhaps the “poster child” here is Sequoia who had reopened their lone fund in 2008 after being closed to new investment for over 20 years, feeling comfortable for the first time that they could effectively manage new money.  They just re-closed the fund once again in the past year.  It seems to be a rule that money follows performance.  A fund that has a couple of really good years will attract waves of new investors.  In my opinion it is irresponsible for the fund company to keep the fund open if they don’t feel they can effectively manage these inflows.  In my opinion this is the definition of greed overruling shareholder interests.
  • A commissioned or fee-based rep who pushes a particular fund family, especially if that family is also his/her employer.  A recent example involves a lawsuit against JP Morgan Chase alleging that their reps pushed the company’s proprietary funds over those from other families.  I suggest asking many questions of this rep if you like them, or better terminating the meeting on the spot if you are a prospective client.

As an individual investor I would caution you against loyalty to any fund family.  Rather start out with the overall portfolio allocation that you are shooting for and then pick the best funds/ETFs to fill those “buckets.”  Ideally this is an outgrowth of your financial plan.  As a practical matter you might be unable to buy some funds due to investment minimums and other factors.  However there are many custodians that offer access to a wide array of funds across many families.  I would generally suggest going that route vs. limiting yourself to a situation where you only have access to a single family or a very small number of fund families.

As is always the case, nothing published on this blog constitutes investment advice nor should you take it as such.  Please see the Disclaimer page for more.

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