The numbers in our mutual fund guide provide insight into which mutual funds are worth owning and which you may want to think twice about. They do not always tell the full story, however. Last year was a case in point.

I’ll start with one of the biggest stories in the mutual fund world, the departure of “bond king” Bill Gross from PIMCO. Among his duties, Gross managed the world’s largest bond fund: PIMCO Total Return (PTTDX). His departure contributed to the fund’s assets under management (AUM) falling from $201.6 billion in the third quarter to $143.4 billion at the end of 2014 (based on data available as of September 30 and December 31, 2014, respectively). Though the departure of Gross led to significant outflows, the fund had previously been incurring net outflows in part due to poor performance. PIMCO Total Return has underperformed its intermediate-term general bond fund peers during three out of the last four years.

Gross now manages the Janus Global Unconstrained Bond fund (JUCTX). This new fund has an inception date of May 27, 2014. As such, there is not enough data to list the fund in this year’s guide or to judge Gross’ performance at his new employer.

A less-publicized story was the poor performance by active managers. In last month’s Editor’s Note, I discussed dispersion, which measures the degree to which components of an index perform alike or differently. Low dispersion environments (the index components perform alike) are difficult for active strategies; dispersion last year among S&P 500 stocks was at the low end of its historical range.

The impact of this environment is reflected in the 2014 returns. Out of the nearly 350 domestic large-cap funds that we track, only 60 matched or beat the index. Put differently, more than 80% of large-cap funds trailed the S&P 500 index last year—nearly double the amount of laggards in 2013.

Compounding matters, many mutual fund shareholders saw their tax bills rise. The Capital Gains Valet website tabulated that capital gains distributions equivalent to between 10% and 19% of AUM were passed along by 453 funds. An additional 64 funds distributed capital gains equivalent to 20% or more of their underlying assets. Since mutual funds are pooled entities, a shareholder can owe taxes on gains he or she never benefited from by simply owning shares on the day capital gains were distributed.

Given this, I want to point out that we include tax-efficiency information in the guide. The tax-cost ratio measures how much of a fund’s average annual return was lost to taxes over the past five years, assuming the maximum marginal tax rate. The higher the ratio, the less tax-efficient a fund is. If you intend to hold a fund in a taxable account, pay attention to this number. The tax-cost ratio doesn’t directly affect funds held in individual retirement accounts (IRAs), though a high tax-cost ratio could be a sign that the manager is not operating the fund in a shareholder-friendly manner.

I also want to call your attention to a new data point that you will see in the Expanded Fund Listings Spreadsheet of this guide: R-squared. This statistical measure explains how much a fund’s return can be explained by movements in the S&P 500 index. It is a useful statistic for analyzing active share among domestic stock funds, meaning whether a mutual fund manager is truly trying to beat the large-cap index or is more of a closet indexer. (Managers are accused of being closet indexers if their portfolios are similar to the benchmark they are tasked with beating. Such funds should generally be avoided.) It can also be helpful for creating a diversified portfolio of a variety of funds, both equity and fixed-income. In both cases, you should always consider what a fund truly invests in (two funds with low R-squared values could be very similar to each other) and how its long-term performance has been, as well as the expense ratio, the tax-cost ratio and the risk index.

Wishing you prosperity,

Charles Rotblut, CFA
Editor, AAII Journal
@CharlesRAAII