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Tom Madell

Tom Madell

Mutual Fund Research Newsletter is a free newsletter which began publication in 1999. It has become one of the most popular mutual fund newsletters on…

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Why You Are Probably Not Any Better Off in 2015

When you invest in a mutual fund, how long are you willing to wait before you start getting good results? Or, when you read an article that gives investment recommendations, what kind of expectations do you have as to how long it would it take for that advice, if followed, to substantially improve your bottom line?

In this article, I will argue that good returns (as good or better than one might expect) will typically be hard to come by over the short term. This is true whether you make your own investment decisions, follow the advice provided by others, or some combination of the two.

This may not be true if you skip funds altogether, and instead, invest in a small number individual stocks. Big price movements can enable certain stocks to excel quickly. Of course, however, the risks with individual stocks are far greater than with most funds; while big gains are indeed possible over a short period, so are big losses.

You may even wonder if is it possible to score "big" with funds. Ask most successful long-term fund investors and you will find that it is, but only on relatively few occasions will it happen when investing in funds over the short term. This year, so far, is proving this point perhaps more so than most. The great majority of both stock and bond funds are showing skimpy returns that are hardly meeting the expectations of most investors.

So what's an investor to do, if anything, and what does it suggest about investment strategies? Should one "change horses midstream," or "stay the course." And, if one is following some prior investment advice, is now the time to chuck that advice in search of greener pastures?

To some, the lack of short-term success might suggest ditching recent choices and/or the advice of those advisors who might have recommended them. But, if so, where or to whom will you turn next? And will your new selections move ahead any faster?

It seems to me that the urge to do something in the face of such disappointing returns reflects the fallacy of thinking that any mutual fund selection, either picked by an investor himself or recommended by anyone else, will be likely to help one to do well as quickly as one might hope. To the contrary, typically, you must "put in your time," often stuck going nowhere if you are to reap the biggest potential rewards of mutual fund investing. As plodding as this may seem, experience has shown that this works far more often than extending the fallacy by reasoning that you will likely do better switching than merely remaining in a currently "going nowhere fast" fund, no matter how promising it appeared when you first bought it.

But why does this slow out of the gate performance so frequently seem to happen? We know that some investors, as well as some advisors, chase performance, meaning that while a fund's strong prior performance may have attracted the investment in the first place, it's also highly possible that investing in already "discovered" funds, likely largely made up of already discovered stocks, means that whatever value was apparent at some earlier point has already been largely realized. In other words, you may have arrived at the party too late.

On the other side of the coin, many investors and advisors seek value, meaning they tend to select funds with relatively "underachieving" characteristics, i.e. funds that would seem to have the potential for a significant turnaround. But such turnarounds may frequently take several years of further disappointing performance before eventually blossoming forth.

As regular readers of my Mutual Fund/ETF Research Newsletter will be aware, I provide forward-looking recommendations of funds that I hope will help in the fund selection process. But just as I have outlined above, investors must not assume that good results will necessarily happen quickly. Typically, I suggest that investors hold these recommended funds for at least three to five years. This should provide a sufficient amount of time necessary for reasonable growth of the underlying fund assets, and in the case of non-index, managed funds, for the fund managers' skills to have a chance to manifest themselves. While any given recommended fund may not perform particularly well for a year or two, the variety of favorable characteristics I have hopefully correctly identified should enable the majority of my fund choices to not disappoint their investors over the longer term.

Of course, sometimes, even over a number of years, some of my choices will not have done as well as expected. But discarding such recommended funds before sufficient time has passed to enable these funds to go from being relatively undervalued, at times ignored or unappreciated, and perhaps underperforming, to becoming more solid and desirable performers is something that we hope most investors won't do.

Investors should note that we don't only recommend funds because we feel they are ripe for a rebound. Many of our recommendations are top-of-the-line funds with excellent managers and/or track records. But even excellent funds may not perform as well as expected over intervals of several years. Unless something about them, or their portfolio positioning has drastically changed, we also usually advise against dropping them just based on short-term considerations.

For those who might feel disappointed with some of my recent recommendations, such as those I presented nearly a year ago in my Jan. 2015 Newsletter, one does not need to look very far to find confirmation of the notion that it may take quite a while for fund selections to manifest superior performance, regardless of who might have recommended them.

Back in Dec. 2014, Morningstar.com published a series of stock and bond fund recommendations that may have investors scratching their heads right now asking the very questions we have raised above.

On the stock fund side, the source of these recommendations was Russ Kinnel, who is Director of Fund Research and Editor of Morningstar Fund Investor, a monthly newsletter for individual investors, and author of several books on fund investing. Of course, Morningstar is an investment research firm whose website is the best known and relied upon U.S. site for mutual funds and has over 3,800 employees.

But even Morningstar isn't likely to give you fund recommendations that will necessarily produce good results over the short term. The following three tables show Kinnel's 10 stock fund picks (along with one bond fund) and their year-to-date (YTD) returns. The picks are found in three separate video reports whose title and source is shown below each table.

One can compare the returns shown with the year-to-date (YTD) performance (as of 11-27) for three Vanguard index funds:

Total Stock Market Index (VTSMX) +2.8%

Vanguard Total International Stock Index Fund (VGTSX) -2.0%

Vanguard Total Bond Market Index (VBMFX) +0.7%

The funds that are currently trailing the above appropriately matched market index fund YTD (also as of 11-27), based on whether they are domestically oriented, international stock, or bond funds, are shown in red; two of the international funds' performances that are virtually identical to the matched international index fund are shown in gray. As you can see, the majority of Morningstar's fund picks aren't doing particularly well this year.

Fund Name 2015 Return (YTD)
Fidelity High Income (SPHIX) -2.9%
Matthews Asian Growth & Inc Investor (MACSX) -3.2
Artisan International Investor (ARTIX) -2.0
Meridian Growth Investor (MRIGX) -0.6
FPA Crescent (FPACX) -0.1
See: 5 Fund Picks for 2015 (and Beyond). Source: Morningstar
Note 1: The first fund shown is a high yield bond fund.
Note 2: You must be a member of Morningstar to view these articles.

Fund Name 2015 Return (YTD)
PRIMECAP Odyssey Growth (POGRX) +6.1%
PRIMECAP Odyssey Stock (POSKX) +3.3
Dodge & Cox International Stock (DODFX) -6.8
See: Kinnel's High-Conviction Fund Picks. Source: Morningstar

Fund Name 2015 Return (YTD)
Vanguard Total International Stock Index Fund (VGTSX) -2.0%
Causeway International Value (CIVVX) -1.4
Harbor International Investor (HIINX) -1.9

Now let's look at nine bond fund recommendations also made near the end of 2014 by Morningstar's Adam Zoll, extolling these picks as "some of the best bond funds available to individual investors today." Mr. Zoll is an assistant site editor for Morningstar and the author of dozens of articles on the site.

Fund Name 2015 Return (YTD)
Dodge & Cox Income (DODIX) +0.2%
Fidelity Total Bond (FTBFX) +0.6
Vanguard Total Bond Market Index (VBMFX) +0.7
Fidelity New Markets Income (FNMIX) +3.4
Templeton Global Bond A (TPINX) -1.4%
Loomis Sayles Strategic Income (NEFZX) -5.6
Metropolitan West High Yield Bond (MWHYX) -0.7
T. Rowe Price Short-Term Bond (PRWBX) +0.8
Vanguard Short-Term Bond Index (VBISX) +1.2
See: Our Picks for Fixed-Income Investors. Source: Morningstar

Across all four tables, the average return for the 10 stock funds was minus 0.9% and for the 10 bond funds was minus 0.4%. All told, then, on both an absolute basis or relative to comparable index funds, the Morningstar picks have a ways to go before being able to acknowledge them as good picks.

Additionally, practically all of the above Morningstar picks above are highly rated by Morningstar's team of fund analysts on each fund's ability to outperform. Therefore, endorsement of these funds not only represents Mr. Kinnel's and Mr. Zoll's opinion, but also apparently reflects the research of many experts on fund analysis on the Morningstar payroll. However, be clear that Morningstar too, as do I, advises that such outperformance is expected when appraised over a number of years.

Therefore, one's conclusion should be that when judging the worthiness of a fund, or predictions of its good performance, periods of up to just one year are typically not long enough. No matter how Morningstar's selections turn out over the next few years, in the best interest of their readers, I would hope that they would follow up with one or more articles giving their readers the actual results, that is, affirming the eventual validity of these predictions or not. After all, anyone can come up with a list of potentially good fund picks looking forward but readers deserve to know how well these picks actually did a number of years later.

In my Jan. 2016 Newsletter, I will present data showing how my prior fund recommendations from one, three, and five years ago have done, along with possibly new fund recommendations for the next three to five years.

As a sidelight to the above article, some of my current Newsletter readers have informed me they found out about my site from one of the numerous articles that, until recently, I published on Morningstar's site. These articles were contributed at no cost to Morningstar and were frequently among the most popular non-Morningstar-employee articles on their site according to their own data; additionally, my articles provided them with ad revenue.

However, back in January of this year, Morningstar informed me that they no longer wished to publish my articles. It can likely be assumed that the reason for this was because they felt my articles were drawing away subscribers from their own mutual fund newsletter, mentioned above, which charges $125 a year; my Newsletter is free. So while Morningstar remains a good source of information and analysis for investors, their site must, by its very nature, evaluate everything they do in terms of their bottom own line, even if it means depriving their readers of useful material. My site's purpose, to the contrary, is solely to provide a not-for-profit/ad free source of helpful information to mutual fund/ETF investors, end of story.


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