Be Aware of the Risks of Comparing Mutual Funds' Peformance

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Question:  I read with interest your column in the Herald last week referring to the comparison of the performance of different portfolio managers.  I used to read Money Magazine, which annually compared the performance of fund managers in each of the main fund categories. I think also:  Top 100 fund managers.  Do they still do that?  If not, where can I get that information.  I have foolishly been out of the market since 2008, and need to return, but have been waiting 6 years for a market downturn, which has never occurred, all the while missing this huge bull market. 

Answer: In the column you are referring to, I explained the difference between time-weighted and internal rates of return, and appropriate uses for each.  Time-weighted returns (TWR) are more appropriate for comparing the performance of investment managers to each other and to indexes.  Internal rate of returns (IRR), also called money-weighted returns, tell you at what rate your investments have grown and whether you are achieving your financial goals. 

To answer your question about where to find comparisons of mutual fund performance, there are numerous sources.  If you subscribe to Morningstar.com, you can compare the performance of mutual fund managers to each other and to a benchmark.  Other websites with similar information include usnews.com, Kiplinger.com, thestreet.com, finance.yahoo.com, and zacks.com. 

The more important question is: what will you do with all this information once you compile it?  It’s easy to pinpoint the mutual fund that outperformed other funds and/or a benchmark in the past, but you should seriously consider every mutual fund’s caveat that past performance is no guarantee of future results.  Numerous studies show that today’s top performing mutual funds are unlikely to stay on top for long periods of time. 

In a Vanguard research paper last year entitled “The bumpy road to outperformance,” the authors concluded that, on average, actively managed equity mutual funds underperform their respective benchmarks.  Also, an equally important but less talked about factor in active management success is the inconsistency inherent in excess returns. 

The study looked at the 15-year records of all the actively managed U.S. domestic equity funds that existed at the start of 1998 and found that only 18% of those funds outperformed their Morningstar style-box benchmark; and those funds experienced numerous and often extended periods of underperformance.  Interestingly, not only did so few funds beat their benchmark, 45% of the original 1540 funds didn’t even survive the 15-year period of the study.

For more insight into how hard it is to pick mutual funds that consistently beat the markets, click here to read my column from July 31, 2014 on the Herald’s website.

Kenneth B. Petersen CFP®, EA, MBA, AIFA® is an investment manager and Principal of Monterey Private Wealth, Inc., a Wealth Management Firm in Monterey. He welcomes questions that you may have concerning investing, taxes, retirement, or estate planning. Send your questions to: Ken Petersen, 2340 Garden Road Suite 202, Monterey, CA 93940 or email them to ken@montereypw.com.