By Gary Brooks, CFP®
Every investor must evaluate different investment options and choose those that seem to be the best fit with what they are trying to accomplish.
Most will look first at past performance. Savvier investors will also try to understand the research capabilities of the investment manager, or team, their process for buying and selling, management fees, and how the fund has compared to its most relevant benchmark.
Investments don’t always proceed as planned, though, and occasionally the standout fund you chose will take a performance detour that leaves you scratching your head.
Morningstar provides mutual fund research and ratings. It uses a five-star scale to rate funds based on past performance and its analysts assign a gold, silver, bronze, neutral or negative rating to suggest the relative strengths of the fund from a forward-looking perspective of overall quality.
In late December Morningstar’s analysts had assigned a gold rating to 120 mutual funds that also carried four or five-star performance ratings.
But even for elite funds, outperformance of a fund’s benchmark or peer group can be elusive. Without scrutinizing every fund in this group, I pulled six that collectively manage over $120 billion. They provide an interesting case study for how to evaluate a fund that has turned – at least currently – from a category leader to a laggard.
Consider, for example, Templeton Global Bond, Oakmark International, Dodge & Cox Balanced, FPA Crescent and AMG Yacktman. Each of these funds has long-term performance (5-, 10-, or 15-year) that places it in the top 10 percent of its category, handily outperforming relevant benchmarks. And each of these funds has also stumbled its way through a tough year in 2015 falling behind at least half of the funds in its category. In a couple cases, funds fell from the top few percent for returns over longer terms to bottom 10 percent performance in 2015. These funds represent U.S. and international stocks and bonds. It’s not a collection of similar funds that all were out of favor with market conditions in the same way. Below-category returns can strike any type of fund in a rising or falling market.
|Fund||Past performance vs. recent performance (2015 through 12/28)|
|Templeton Global Bond||Top 2% of international bond category over 15 years, top 1% over 10 years, 52nd percentile 2015 YTD.|
|Oakmark International||Top 4% of foreign large blend funds over 15 years, 3% over 10 years, 6% over 5 years, 78th percentile 2015 YTD.|
|Dodge & Cox Balanced||Top 4% of moderate allocation category over 15 years, top 3% over 3 and 5 years, 78th percentile 2015 YTD.|
|FPA Crescent||Top 1% of moderate allocation category over 15 years, top 6% over 10 years, 69th percentile 2015 YTD.|
|AMG Yacktman Service||Top 1% of U.S. large cap blend category over 15 years, top 2% over 10 years, 90th percentile 2015 YTD.|
Seemingly, peer-beating performance over longer terms should carry more weight in the minds of investors than significantly lagging performance over the short term. But the human condition causes us to overweight recent outcomes and be susceptible to the temptation to react.
What if you just recently made the decision to move into a formerly top fund and your entire experience has been poor? It can be tough for people to fathom but it’s commonplace that two people invested in the same, gold-rated, five-star fund could have very different return experiences based on when they purchased shares.
If you are performing a year-end evaluation of your investments, there are several points you should consider before deciding to either sell a fund, buy more shares, or do nothing.
Has the investment process or management team changed materially from when the strong longer-term performance was achieved? It may not have. Even excellent managers are not immune to bad luck and the randomness that is evident in markets where investor sentiment/psychology are influential. Alternatively, if people and/or process have changed, that may be enough reason to move your money.
Have the assets in the fund grown too large? Funds with outstanding track records could have incoming daily cash in the millions from new investors. It is generally much more difficult for a fund manager to continue producing standout results with the most recent cash flow than it was with the initial money.
Is your assessment of performance based on an appropriate comparison? Is the performance poor relative to the fund’s peers or just to your expectation? Comparing a U.S. small-cap stock fund, value-only strategy or international fund to the S&P 500 can be apples and oranges and misinformed.
You may simply decide to wait. Even a full year of weak performance might not be a problem if the fund still aligns with your risk/return profile, time horizon and other points which led you to choose it in the first place. Patience is an important virtue of successful investors. We know that persistent outperformance is an investment unicorn. This is why smart investors mix actively managed funds with passive index funds in a diversified portfolio. Many active managers have delivered great value over time but none do it every quarter or year.
The last thing you should do is get caught up in the self-doubt and missed opportunity of “if only I had bought … (Facebook, Netflix, Amazon, etc.)” This is what leads to performance chasing and harming your pursuit of financial security.
Brooks, Hughes & Jones Wealth Advisors — Gig Harbor, WA — www.bhjadvisors.com