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


The Rolling Stones' "Tongue and Lip Desig...

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

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Evaluating Mutual Funds, Numbers Can Be Deceiving


When evaluating a mutual fund looking only at the trailing numbers may not tell you the whole story. Let’s look at a couple of examples.

Fidelity Balanced Fund (FBALX) has a solid trailing track record. The fund ranked in the top 7% of all funds in its category for the 10 years ended 12/31/09 and in the top 14% for the trailing 15 years. The fund ranked in the top half of its category in 9 of the 10 years of the decade 2000-2009.

However, the fund laid a real “egg” in 2008 losing 31.33% and ranking in the bottom 24% of the funds in its category. This is a balanced fund (its Morningstar category is Moderate Target Risk). This type of fund is balanced between stocks and bonds and should be a somewhat stable component of one’s portfolio.

In November of 2008, Fidelity revamped the fund, placing it in the hands of multiple managers for different parts of the fund’s portfolio. The new lead manager is Robert Stansky, a former manager of giant Fidelity Magellan. Essentially, the group that compiled the fund’s mostly solid track record has been replaced.

The new group did a credible job in 2009 earning a return of 28.05% for 2009, the fund ranked in the top 24% of its category.

Should you buy this fund? Difficult to say. The fund’s trailing track record is pretty meaningless with the new fund management team in place. The “new guys” did well in ’09 an outstanding year for both the equity and fixed income markets. The question investors should ask themselves is whether or not they feel that this new management team and their philosophy fits with their objectives for a balanced portfolio.

Dodge and Cox Stock (DODGX) ranks in the bottom 20% of the Large Value category for the three years ended 12/31/09 and in the bottom 34% for the trailing five years. However, the fund ranked in the top 4% for the trailing 10 years and the top 2% for the trailing 15 years.

Much of the fund’s management team has been in place for the entire 15 year period. The fund’s nearer term track record includes 2007 when the fund ranked in the bottom 38% of its category and 2008 when the fund lost 43.31% and ranked in the bottom 9% of its category.

Dodge & Cox made the mistake of replicating what worked for the fund in 2001-2002; years when the fund placed in the top 3% and 4% of its category respectively. This period marked a major market drop starting with the dot-com bubble bursting and continuing with the post-911 market decline. This was a period, however where certain parts of the market proved to be relatively safe havens. This included many traditional value stocks such as financials.

The 2008-2009 market decline saw virtually no safe havens. Financial and other traditional value type stocks were hit hard. Many of the financial holdings of this fund took a real beating. Did the managers of the fund suddenly lose their touch? Or was their investing style simply out of style?

The fund rebounded nicely in 2009 earning 31.27% for the year and ranking in the top 14% of the Large Value category.

Should you buy or own either fund? Should you sell either or both if you already own them? In both cases the numbers might lead you to one decision, but in both cases an investor should look beyond the numbers in reaching their decision.

Please feel free to contact me for a review of your investments.  Check out our Financial Planning and Investment Advice for Individuals page for more information about our services.  

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