The article was published in the September issue of Morningstar FundInvestor.
It's great to have the 2000-02 bear market so far in the rearview. One of the strangest bear markets, it crushed tech and other large-growth stocks while leaving bonds and even a lot of equities outside of large growth unscathed. Those of us who stayed diversified rather than jumping on the tech bandwagon had a relatively easy go of it, though it was still very stressful to live through.
Vanguard Wellington (VWELX), for instance, delivered a solid 5.8% 15-year investor return thanks to a prudent investment style, low costs, and no surprises.
So, it was quite different from the 2007-09 bear market, which crushed almost everything but was especially hard on large value--the home of big banks and insurers. This is why I find 15-year total returns and 15-year Morningstar Investor Returns so enlightening. They capture the craziest part of the dot-com bubble and the brutal bursting of the bubble that followed. Those few years perfectly illustrated the notion that markets tend to overdo things in both directions.
I've run the total returns and investor returns for the Morningstar 500 funds, and I'll highlight those with the best and worst 15-year investor returns. Investor returns are an estimate of the returns a fund's shareholders actually received. Because only a minority of investors hold a fund's shares for an entire 10- or 15-year period, few of them earn the exact same return as the fund's stated return.
- source: Morningstar Analysts
Investor returns use fund flows to adjust returns so that periods when more investors hold the fund carry greater weight. Across the fund world the typical investor falls about 0.92% per year short of stated fund total returns. The gap between investor returns and total returns essentially tells you how well investors timed their investments. Both the absolute investor-return figure and the gap are useful information. The more important figure, though, is the investor return as that tells how investors actually fared. A small gap isn't much consolation if the total return and investor return are meager.
All this comes with a caveat. Because timing is so important to investor returns, there is some luck involved. A fund launched near the bottom of the market might get inflows just as the markets are turning up. That's great, but of course a fund only launches once. So, some funds that did exceptionally well had some lucky breaks. There are some valuable principles to glean from the big picture, however.
While you can see some categories repeated among the top and bottom funds, the next 15-year returns might not match them. The greater lesson here is which kind of funds work well and which ones don't.
Volatility and extreme returns lead to bad results because they mean the correction to a rally will likely be more severe. Funds with huge three-year returns should spark as much concern as excitement. Funds that work well for investors are those with more consistent performance, consistent management, and consistent strategies. You'll find them more often at strong fund companies where manager turnover is low and a shareholder orientation is embedded throughout the firm's values. Often funds with more-moderate risk profiles are easier to use, too. Boring allocation funds are good bets to produce solid investor returns. Low-cost funds are able to more consistently outperform, and their managers often take on less risk because they have a lower hurdle to overcome.
The Top Investor Returns
You don't see this too often. Yacktman Focused (YAFFX) produced a strong 8.85% annualized 15-year return for the period ended June 30, 2013. Yet the typical investor earned a 14.12% return. However, the fund was tiny during both bear markets. It ended 2008 with just $65 million in assets. That surged to $666 million the next year and kept growing to $10 billion today. Not only did most shareholders miss those bear markets but they also missed the fund's bottom-decile performances in 2004 and 2005.
Now that the fund is quite big, it won't have such luck in the future. However, it has produced strong risk-adjusted performance and, despite a sluggish 2012, it has done well even as assets have grown. I doubt it will be at the top of this list in five or 10 years, but it may well be ahead of most of its peers. Indeed, Yacktman (YACKX), which didn't have as much timing fortune, still produced a strong 11.6% investor return. It was launched earlier, so its start date wasn't a big help on the investor-returns front, though the flow pattern was similar.
Vanguard Energy (VGENX) has long been a big fund, yet its shareholders have returns about 100 basis points above the fund's already big 11.61% annualized total return. Key to that story is that the fund closed amid the huge rally in energy stocks from 2003 to 2007. As a result, most of the shareholders were there for most of the huge four- to five-year run in which returns ranged between 19.7% and 44.6% each year. They couldn't come in late. The fund has been mostly in redemptions even after it reopened. That's a pretty good thing because 2009 was the only really good year in the past five. Like Yacktman Focused, this fund also held up much better than its peers in 2008 so that more shareholders were around for the rebound. Look for funds with a history of closing and you'll be on the right path.
Matthews Asian Growth & Income (MACSX) shareholders didn't make as much as the fund's 15-year total returns, but because total returns were 14.7% annualized, they could spare a little. The fund holds promise for solid future investor returns, too, as it moderates the extremes of emerging-markets risk while still providing the potential for hefty returns--not that I'd be counting on 15% annualized the next 15 years.
Wasatch Core Growth (WGROX) produced strong investor returns simply by having above-average returns with below-average risks. Well, kind of. The fund's 15-year returns were bettered by the typical investor's 11.2% annualized returns. While modest risk is part of it, the fund also presented an unusual case in which it had few shareholders in each of the past two bear markets. For the 2000-02 bear market, it was a tiny fund that held up much better than most small-growth funds. Wasatch's focus on actual earnings rather than clicks and hype made it one of the few growth shops to come out of that market with an enhanced reputation.
Thus, in 2003 the money poured in. In fact, the fund took in more than $1 billion that year and really hasn't had meaningful inflows in any year since. That same caution that helped in the bear market held it back in the rally even though it had positive returns. That led investors to bail on the fund just as the next bear market hit. This time the fund didn't even hold up particularly well on the downside but instead rebounded very strongly in the rally.
Royce Special Equity (RYSEX) is just the sort of defensive fund I'd expect on this list. Charlie Dreifus is a stickler for clean balance sheets, and that makes for a defensive portfolio. The fund has a 9.9% 15-year total return and 11.2% investor return. The fund has closed to new investors when assets have grown, too.
Two Fidelity funds are next on the list. Fidelity wasn't as extreme as Janus, but it does have a lot of growth funds that tend to win the rallies and lose the corrections. Fidelity Select Technology (FSPTX) and Fidelity Growth Discovery (FDSVX) have respectable total returns, yet they didn't make investors any money. Growth Discovery's path hasn't really been exceptional, but it did switch to a growth strategy from a core strategy when Jason Weiner returned for a second run in 2007. That came following a poor stretch as a large-blend fund under Adam Hetnarski. Weiner had a good 2007 only to have dismal 2008 and 2009. Thus, too many investors had given up before the fund's strong 2009 and 2010.
For Fidelity Select Technology, returns and managers have both been too volatile for most investors. The fund had eight managers over the past 15 years. Nearly all of its returns in the past 10 years have come in 2003 and 2009, so it required either great patience or great timing.
As you can see, getting good results for investors requires effort from investors and fund companies alike. Fund companies need to provide stability in management and process and close funds in a timely manner. Investors need to understand a fund's risks, set expectations appropriately, and lean toward more-conservative funds when in doubt. If an asset class has had a great run, consider trimming or at least rebalancing to where you were before. Patience is one of the greatest virtues in investing.
Russel Kinnel has a position in the following securities mentioned above: RYSEX
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