Mutual Funds and The Rolling Stones: Time is on Their Side

One of the Rolling Stones’ greatest hits is called Time is on My Side.  Given the potential impact that the passage of time will have on the trailing five year returns of many mutual funds  by the end of 2013, the fund companies should be singing this song as well.

In a recent article on Market Watch Chuck Jaffe highlighted this quirk as cited by Morningstar.  According to Jaffe and Morningstar:

“For example, the average large-cap growth fund entered September with a five-year annualized return of 6.38%, according to Morningstar Inc. If the market simply stays flat and the average fund stands still to the end of the year, that five-year average will be 9.2% once September is wiped off the books, and will reach 15.16% by the end of the year.” 

As a case in point, the Vanguard Growth Index (VIGSX) fund’s five year annualized return as of June 30, 2013 was 7.15%.  At the end of the most recent quarter ending September 30, 2013, the fund’s five year annualized return stood at 11.73%.  This is a combination of fund’s 11.99% loss for the third quarter of 2008 dropping off of the five year record and the addition of the fund’s very solid gains of 8.48% for the most recent quarter.

If we carry this forward, at the end of the 2013 the loss of 23.81% for the fourth quarter of 2008 will fall off of the fund’s five year track record.  As Jaffe and Morningstar indicated even a flat return in the fourth quarter of 2013 will result in a significant jump in the fund’s trailing five year track record at the end of 2013, erasing a large portion of the financial crisis from the track record of this and many funds.

A marketing boon for mutual fund companies 

Just like the folks who market breakfast sausage, cars, or life insurance, mutual fund marketers are paid to accentuate the positive aspects of investing in their funds.  The mere passage of time will result in a marketing boon for these folks.

Be leery of the facts

If a mutual fund company touts the fund’s sheer numerical return, this is pretty meaningless.  Mutual fund returns should be viewed in the context of the fund’s peer group.  For example an average annual five year return of 10% might sound great, but not if 90% of the other funds in this same investment category (peer group) did better than that.

Further look at the fund’s risk-adjusted returns.  Did the fund take inordinate risks to achieve their returns, or did they do this with less risk than the average fund?

The past may not be a good indicator of the future

Past returns are not an indication of future results is a standard disclaimer in our industry.  The past is the past.  Many things can change.  Perhaps the fund manager who racked up this stellar track record has moved on.  In the case of small and mid cap funds, gathering too much money to effectively manage can be an issue and is often the result of outstanding performance.  Money has a habit of chasing returns.

Don’t be fooled by the hype that will surely surround these returns on steroids.  Always analyze any mutual fund’s results in terms of the potential implications of this performance and structure on future relative performance.

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Photo credit:  Wikipedia