The news media is full of articles on mutual funds. Most, it seems, are dramatic tales about funds that have had a recent spell of good performance, sprinkled with anecdotes of swashbuckling fund managers. The implied message is that the featured funds are great investments. But are they, really? Caveat Lector -- Reader Beware. It's always a good idea to read the financial press with a skeptical eye, to question claims and assumptions and to extract the sound guidance from the surrounding hype.
We'll look closely at one recent article about mutual funds. Spoiler alert: the punchline is that you're better off sticking with low-cost funds than paying too much attention to recent performance or anecdotes about fund managers. But learning to debunk some of the common themes in mutual fund journalism will make you a savvier investor.
The Wall Street Journal recently (August 11) carried a profile of Fidelity's Magellan Fund. Magellan has been an underperformer in recent years, but was doing well from the beginning of 2007 through early August. The WSJ headline: "Magellan, 99-Lb. Weakling No More"
in a turnaround under [manager Harry] Lange -- and a rare bit of good news for Fidelity Investments -- this year Magellan is beating 83% of comparable growth funds, according to Chicago fund watcher Morningstar Inc. It is returning 9.9% through Thursday, 6.3 percentage points ahead of the Standard & Poor's 500-stock index. The fund "has gone from minivan to large race car," Morningstar wrote recently.The story of Magellan's fall from glory and recent uptick might be interesting drama to those who follow fund returns like baseball. But as actionable advice to the investor who's looking for a fund to invest in, not so much.
The implication of the article and the Morningstar quote about Magellan being a "large race car" is that investors can expect an investment in the Magellan Fund to earn above average returns, perhaps even recapture some of the fund's past magic. Unfortunately, there's not much in the article that supports that claim or is all that useful for predicting Magellan's future performance. The strongest bit of information is the fact that Magellan was beating 83% of "comparable growth funds" for the year-to-date (as of August 11). But that by itself is unremarkable. Most funds, over time, will enjoy similar success in some year.
This article prompted us to perform some statistical analysis of historical fund data. We looked to see how funds with a similar short-term spurt fared in subsequent years. We'll provide all the details in a later post. But historically, low costs have been a better predictor of future success than short-term performance has.
There are several other points in the article worth mentioning:
* Discussing the current Magellan Fund in the same breath as the Magellan Fund which years ago had truly stellar returns makes little sense. Magellan had its best years under Ned Johnson and Peter Lynch in the 1970s and early 1980s. A comparison of year-by-year returns between the Magellan Fund (FMAGX) and the Vanguard S&P 500 index fund (VFINX) for the 30 years from 1977 through the end of 2006 shows that FMAGX beat VFINX in 17 out of 30 years -- 7 of which were during 1977 - 1983. Since 1984, FMAGX has underperformed the index fund 13 out of 23 years. After Lynch resigned as fund manager in 1990, VFINX has beaten FMAGX in 11 of 17 years. And this is before taxes. (We'll have a more detailed comparison between FMAGX and VFINX, both pre-tax and after-tax in later posts).
* Magellan is now in the hands of its 4th post-Lynch manager. Each successive manager has made changes to the portfolio and investment style. In essence, the Magellan Fund is little more than a brand name where the actual product contents can change at any time. This is a hazard with actively managed funds in general, whose investment process can vary widely with its managers, who can leave at any time.
* Be careful when a fund is compared to a narrow peer group, e.g. "this year Magellan is beating 83% of comparable growth funds". What exactly are "comparable growth funds"? Here at personalfund.com we use the Lipper fund database (not Morningstar). On October 12 last year, Lipper ranked Magellan near the bottom of its peer group, in the 6th percentile. The very next day Magellan shot up to the 63rd percentile of its peers, somewhat above average. But Magellan's performance had not improved, Lipper had simply re-assigned it to a different peer group, from "Large Cap Core" to "Large Cap Growth". But is "Large Cap Growth" necessarily the closest peer group for Magellan? In this recent interview with Kiplinger, manager Harry Lange described Magellan as a "go anywhere" fund, which to him means that
the fund can invest in domestic and international, large cap and small cap, growth and value, the whole range.There's no requirement for a fund manager to strictly adhere to the somewhat artificial boundaries imposed by the "style boxes". But a fund's performance is more determined by the styles of the stocks that it owns than by the manager's individual stock picks within that style. So one should also not ascribe too much meaning to the ranking of a "go anywhere" fund within a more rigidly constrained peer group.
* But let's assume for argument's sake that Magellan is mostly a Large Cap Growth fund, even though it apparently contains a blend of "styles". So it's misguided to make this comparison: "[Magellan] is ... 6.3 percentage points ahead of the Standard & Poor's 500-stock index". But much of that difference would have been attributable to the fact that Large Cap Growth stocks as a group have outperformed the S&P 500 this year, and consequently so has the average Large Cap Growth fund. As of August 9, when the article was written, the S&P 500 was up 3.6% for the year, Magellan was up 9.9%, and the average fund in Lipper's Large Cap Growth universe was up 6.9%. Magellan was still ahead of comparable funds, but not nearly as much as the comparison with the S&P 500 would suggest. (As of yesterday, October 8, Magellan was up 19.4%, the average Large Cap Growth fund up 17.0% and the S&P 500 up 11.0%). But every style cycles between good years and bad years. Last year, Magellan also edged the average Large Growth fund 7.2% to 5.8% -- but the S&P 500 was up 15.8% for the year. If Magellan were to remain mostly in Large Growth, you can expect it to trail the market the next time the Large Growth category falls out of favor.
It's reasonable to ask why the Magellan has outperformed its "comparable growth peers" for the last two years. Is it because the manager knows how to pick the best Large Growth stocks? Or because the manager is also investing in other styles that happen to be beating Large Growth at the moment? Hard to say.
More details in upcoming posts on Magellan's past and recent performance and how to consider it (and similar information about other funds) when making investment decisions.
Posted at October 09, 2007 03:52 PM | Permalink | Personal Fund Blog Main Page