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  • The Top Mutual Funds Over Five Years: Credit the Bull and the Calendar

    by Charles Rotblut, CFA

    The Top Mutual Funds Over Five Years: Credit The Bull And
the Calendar Splash image
    This year’s list of the top mutual funds over five years is notable for several reasons.

    First, this is the first time since we started listing the top five-year performers in 2010 that no bond, precious metals or emerging market funds have a top overall ranking. Among the 10 best performers (we expanded the list from six to 10 last year), nine are domestic funds. Oberweis International Opportunities fund (OBIOX) is the only top performer to primarily invest in foreign securities.

    Second, a big shake-up has occurred in the category rankings, which are shown in Table 1. The best-performing bond category, convertible bond, only ranks ninth. The next best bond category, corporate high-yield, is in the 23rd spot, about midway in the rankings of the 47 categories. Last year, bond categories occupied the top four spots and eight of the top 10 spots.

    Third, as we discussed in the 2014 mutual fund guide (February 2014 AAII Journal), a shift in the calendar significantly boosted the five-year performance of stock categories and equity-focused mutual funds. The negative returns of 2008 have been replaced with 2013’s big gains. The starting values for calculating five-year performance have also changed, with the depressed year-end 2008 net asset values replacing the higher year-end 2007 net asset values. This why the large-cap stock, mid-cap stock and small-cap stock categories appear in the top 10 for the first time since we started publishing the category ranking in 2010.

    Fourth, the calendar-year shift highlights the funds that perform better in an environment that rewards riskier strategies. This year’s top 10 funds have an average total risk index score of 1.42, versus the 1.22 average risk index score for last year’s top funds. During bullish market conditions, opting for funds with higher total risk indexes can lead to higher returns. This factor makes this year’s list something to consider saving for the next bull market, with the caveat that funds and market conditions change over the time.

    Fifth, the strong five-year performance made it easy to forget how risky leveraged funds actually are. Solely based on their five-year 48% annualized gains, Rydex Dynamic NASDAQ-100 2X Strategy (RYVYX) and ProFunds UltraNASDAQ-100 (UOPIX) might seem like funds you should have held in your portfolio. What the statistic doesn’t tell you, however, is that both of these funds plunged by more than 80% during the last bear market. Bull markets are deceptive when it comes to risk—they lure investors into thinking they can handle more volatility than they actually can from a financial or a psychological standpoint. It’s easy to be risk tolerant when prices are rising; it’s difficult to tolerate risk when you see your portfolio dropping in value.

    For this reason, we have purposely excluded ultra and similar leveraged mutual funds from this year’s list of the top funds over five years. While such funds can be good trading vehicles when you correctly guess the future direction of the market, they also significantly penalize you for being wrong. Ultra funds’ performance over the last five years masks the threat of such a financial penalty. Furthermore, their inclusion would have knocked out several funds that don’t use leverage, have greater widespread appeal and are more suitable for many investors. Table 3 includes the best-performing leveraged funds over the last five years.

    Two Funds Stay on Top 10 List

    The top of Table 2 shows the overall top 10 performers over the last five years. Two funds in last year’s top 10 list of overall performance also made this year’s list: Matthew 25 (MXXVX) and Fidelity Select Retailing (FSRPX). Matthew 25 realized a five-year annualized return of 31.5%, as its yearly returns were below 30% only once during the past five years. Fidelity Select Retailing’s five-year annualized return of 30.2% reflects a far more volatile performance. The fund’s yearly returns ranged from as low as 3.3% in 2011 to as high as 57.8% in 2009. The differences show the importance of looking at not only long-term performance, but also the yearly returns that led to it.

    The impact of the calendar-year shift is very evident with both funds. Matthew 25 ended 2012 with a five-year gain of 11.0%, versus 31.5% at the end of 2013. Fidelity Select Retailing ended 2012 with a five-year gain of 12.9%, versus 30.2% at the end of 2013. Again, the difference is the replacement of a bad year with a good one and the inclusion of a low starting value for calculating performance.

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        Total Bull Bear
      5-Yr Annual Risk Market* Market*
      Avg Return Index Return Return
      (%) (X) (%) (%)
    Consumer Discretionary Sector
    Technology Sector
    Health Sector
    Small-Cap Stock
    Mid-Cap Stock
    Industrials Sector
    Communications Sector
    Large-Cap Stock
    Convertible Bond
    Consumer Staples Sector
    Global Stock
    Real Estate Sector
    Natural Resources/Commodities Sector
    Target Date: 2050-2059
    Target Date: 2040-2049
    Financial Sector
    Real Estate Global Sector
    Emerging Stock
    Target Date: 2030-2039
    Energy Sector
    Foreign Stock
    Regional/Country Stock
    Corporate High-Yield Bond
    Utilities Sector
    Target Date: 2020-2029
    Balanced: Domestic
    Balanced: Global
    Target Date: 2010-2019
    International Bond: Emerging
    Target Date: In Retirement
    General Bond: Long-Term
    Muni National: High-Yield Bond
    General Bond: Intermediate-Term
    Muni National: Long-Term Bond
    International Bond: General
    Inflation-Protected Bond
    Long-Short Category Average
    Muni National: Intermediate-Term Bond
    General Bond: Short-Term
    Mortgage-Backed Bond
    Government: Intermediate-Term Bond
    Muni National: Short-Term Bond
    Government: Short-Term Bond
    Government: Long-Term Bond
    International Bond: Currency
    Precious Metals Sector
    Contra Market
    *Bull market is defined as 3/1/2009 through 12/31/2013. Bear market is defined as 11/1/2007 through 2/28/2009.
    Source: “The Individual Investor’s Guide to the Top Mutual Funds 2014,” February 2014 AAII Journal. Data from Morningstar Inc. is through 12/31/2013.

    Matthew 25 follows a blended growth and value strategy in targeting companies fund manager Mark Mulholland thinks are attractive. Mulholland seeks out four key traits in a stock: a good business model, capable management, sound financials and a price at or below fair value. Though classified as a large-cap fund, Matthew 25 can hold mid-cap and small-cap stocks. The portfolio is concentrated, with just 38 holdings and more than 60% of the portfolio allocated to the 10 largest positions. Turnover is low at 23%, implying a buy-and-hold approach by Mulholland and good stock selection. The expense ratio of 1.15% is above average for a large-cap fund, and a 2.0% rear load is charged.

    Fidelity Select Retailing, as the name implies, invests at least 80% of its assets in retailing stocks under normal conditions. This strategy makes the fund very dependent on perceived trends in consumer spending. It holds just 36 stocks, but unlike Matthew 25’s Mulholland, manager Peter Dixon moves in and out of stocks, as is evidenced by the turnover rate of 119%. Turnover rates over 100% imply the entire portfolio has been replaced over a 12-month period. Frequent trading creates extra costs for shareholders and is a drag on performance, even though Dixon has delivered good returns over the past several years. Fidelity Select Retailing fund has an annual expense ratio of 0.86% and a rear load of 0.75% (both fees are separate of the transaction costs incurred by the fund).

    More Total Risk, But Less Category Risk

    As previously noted, the average total risk index score for this year’s top 10 best-performing funds was notably higher than last year’s top 10: 1.42 versus 1.22. The total risk index compares the volatility of a fund’s returns against all other funds tracked in our mutual fund guide. Scores above 1.0 signal above-average volatility, while scores below 1.0 signal below-average volatility. The rise in the average total risk index score is not surprising, given the absence of bond funds and the simple fact that taking on greater risk in a bull market is often rewarded.

    What’s interesting, however, is this year’s top funds were not much riskier than their worse-performing peers. The average category risk index, which compares a fund’s volatility against all other funds in its category, was 1.05. This was a decrease from 1.14 last year. Five top-10 funds were less volatile than their peers: Aegis Value (AVALX), Buffalo Emerging Opportunities (BUFOX), Fidelity Select Chemicals (FSCHX), Fidelity Select Retailing and T. Rowe Price Media & Telecommunications (PRMTX). The one fund skewing the average higher was Fidelity Select Automotive (FSAVX), which had a category risk index score of 1.46 and a total risk index of 1.92. During the past five years, this fund’s returns have ranged from a loss of 26.2%, in 2011, to a gain of 122.2%, in 2009.

    Fund Listings

    Table 2 shows the top funds over five years for each category.

    In addition to five-year performance, returns are displayed for each of the past 10 years and for the most recent bull and bear markets. Returns that are in the top 25% of all funds within the investment category are shown in boldface.

    Data through year-end 2013 on all mutual funds tracked by AAII is available in a downloadable Excel file at AAII.com. The online guide contains roughly 1,630 funds and reports additional data, portfolio manager and tenure, fund minimums and additional fund portfolio characteristics. Go to www.aaii.com/guides/mfguide to access the expanded version of AAII’s “Guide to the Top Funds 2014.”

    Other pertinent information presented includes yield, tax cost ratio, risk, portfolio composition and expenses. Risk and expense numbers that are in the lowest 25% of all funds within the investment category are shown in boldface.

    Look Beyond Performance

    Five-year performance figures are very useful when evaluating fund managers because they balance consistency of performance with changing market and economic conditions. Any fund manager can get lucky over the course of a single year, but talent and a good strategy are required to outperform over a period of several years. A five-year period strikes a balance of offsetting the impact of a single year’s performance without being so long that comparisons between funds become harder because of changes in managers and objectives.

    Even though five years is a good time period for fund evaluation, an understanding of market and economic history adds context to the numbers. Solely building a portfolio by selecting funds from the categories with the best current five-year performance would result in a portfolio that is heavily skewed toward domestic sector funds and domestic small-cap funds. Sector funds are dependent on the trends of the industries they track and tend to overweight the largest 10% of their holdings. Small-cap funds tend to incur more return volatility, as evidenced by the average total risk index score of 1.40 for Buffalo Emerging Opportunities, Aegis Value and Hodges Small Cap (HDPSX) funds.

    Consistency of performance matters. Aegis Value ranks as the second-best small-cap fund (and the best small-cap fund still open to new investors) with its five-year annualized gain of 32.1%. The fund lagged its category peers, however, in 2011 and 2013. Furthermore, its five-year performance is inflated by a 91.4% gain in 2009. In contrast, Hodges Small Cap has topped its peers during each of the past five years.

    Be sure to take the extra step of looking at how long the current manager has been running the fund. For example, Joshua Spencer took over T. Rowe Price Global Technology (PRGTX) in June 2012. Though his fund has ranked in the technology sector category’s top quartile for annual performance during six out of the last 10 years, the fund’s performance prior to 2012 does not provide much insight as to how Spencer will perform in the future. (The online version of this article, available at AAII.com, shows when the current manager for each fund started.)

    As previously stated, you should also consider how much risk a fund’s strategy incurs. Cambiar Aggressive Value Investor’s (CAMAX) category risk index score is more than double that of large-cap peer Marsico Flex Cap (MFCFX), 2.02 versus 0.93. This big difference in risk exists even though the two funds’ five-year returns are almost identical: 26.8% versus 26.3%, respectively.

    Risk is also relative to the category in which a fund operates. Wasatch International Opportunities’ (WAIOX) total risk index score of 1.35 may seem high, but the fund’s category risk index of 0.98 shows that it incurs less risk than the average foreign stock market fund.

    Costs Matter

    Lower expenses are always preferable, though—as is the case with performance—costs are relative. A domestic fund is cheaper to operate than a fund that targets foreign investments. For example, the 0.47% expense ratio for American Century Government Bond (CPTNX) is not comparable to the 0.90% expense ratio for Managers Global Income Opportunities (MGGBX).

    In addition to the expense ratio, a maximum load may be listed in Table 2. A load is a fee charged for buying (front-end load) or selling (back-end load or redemption fee) a fund. These fees are often reduced or waived if the fund is held for a certain period of time or if a certain dollar amount is invested. For example, Fidelity charges a 0.75% redemption fee on shares held less than 30 days for several of its sector funds, including Select Automotive, Select Retailing and Select Chemicals (FSCHX) funds. Terms can vary by fund, so read the mutual fund’s prospectus for specific information about the load and other charges.

    If a mutual fund is held in a taxable account, the tax-cost ratio should be considered. Since mutual funds are composed of pooled investment dollars, net capital gains are passed onto shareholders of record at the time the fund sells the security. Shareholders must pay taxes on these capital gains, regardless of whether they sold any shares of the mutual fund itself or not and regardless of how long they have owned the mutual fund.

    Portfolio turnover plays a role in both expenses and tax costs, with higher levels indicative of more active trading by the fund manager. Investors seeking lower costs and/or less tax exposure may want to opt for funds with lower portfolio turnover ratios.

    If costs or tax efficiency are among the key characteristics you examine when looking at mutual funds, consider an index fund. Since they don’t rely on the skills of an active manager, their costs tend to be lower. Some actively managed funds do a good job of controlling costs, however. For example, PRIMECAP Odyssey Aggressive Growth’s (POAGX) portfolio turnover ratio is a mere 11% and its tax-cost ratio is 0.3%. To put these numbers into perspective, the average mid-cap stock fund has an average turnover rate of 65% and an average tax-cost ratio of 0.6%.

    Further Evaluation

    Before investing in any fund, read the prospectus. Have a clear understanding of the fund’s objective, strategy, risks and cost structure.

    Next, obtain the latest fund report and review the holdings. What securities are currently being held in the fund? How much of the portfolio is concentrated in each of the key holdings? If the fund manager provides commentary, read it to get additional insight into his thought process.

    Finally, remember that even though funds are intended to be long-term investments, you should never buy and then forget about them. Mutual funds should be periodically monitored to make sure the objective has not changed and the fund is performing as expected, given prevailing market conditions and historical performance.

    Pay attention not only to current performance, but also to current performance relative to historical performance and relative to the fund’s category average. A mutual fund that lags in market conditions that it historically has done well in should receive more scrutiny than a mutual fund that is following its historical volatility trends and is producing returns that are similar to those of its peers.

    Table 3. Top Funds Over Five Years, Adjusted to Included Leveraged Funds

    This listing of the top funds has been modified to include leveraged funds. In categories where a leveraged fund has a higher five-year return than a non-leveraged fund, the leveraged fund is shown and the non-leveraged fund is excluded. This shows how the inclusion of leveraged funds alters the top fund rankings on a category basis. Leveraged funds commonly include terms such as “2x” or “ultra” in their names.

    Charles Rotblut, CFA is a vice president at AAII and editor of the AAII Journal. Follow him on Twitter at twitter.com/CharlesRAAII.


    Fred Evans from OH posted over 2 years ago:

    Several good points in this article may suggest the need for short term, new performance metric. What do you think about publishing the average of the 5 yr performance and the 6 year performance. This mutes the effect of sudden drop in return that may actually reward funds that did a exceptionally bad job in the year prior to the 5 yr period. It may also provide a more relevant metric than the 10 yr average return.

    T Bishop from CT posted over 2 years ago:

    I triued to buy some PRIMECAP Odyssey Agg Gr (POAGX) a couple days ago and it was closed to new investors. SO I'd put a c in front tof that before anybody else reads this and gets their hopes up. Perhaps this happened since year end. THis might be a good reason to get asome $ into any funds you like before they close. And if they do well they will attract attention and close.

    John Mac Dougall from Florida posted over 2 years ago:

    I have heard a tax advisory gentleman speak about the disadvantage(s)of owning mutual funds. His recommendation is do not own them.

    Alfred Hess from NC posted over 2 years ago:

    Why can't tables 2 & 3 download to my computer running Windows-7?? Al

    Ken Gnaster from IL posted over 2 years ago:

    how do you activate cookies on a laptop

    Charles Rotblut from IL posted over 2 years ago:


    This page in the AAII.com FAQ gives guidance on cookies.


    Suzanne Benton from CT posted over 2 years ago:

    The list scrolls down to fast - can't read it properly - needs adjusting.

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