In our latest five-year performance rankings, the best-performing mutual fund categories are mostly reshuffled from last year’s list.

The health and consumer discretionary categories remain essentially on top, with health now ranking number one and consumer discretionary ranking second. Small-, mid-, and large-cap stock also continue to remain in the top 10 of all categories. Table 1 shows the five-year ranking for all fund categories.

One category that broke into the ranks of the top performers is real estate. Domestic real estate funds had a great 2014, with an average return of 27.6%. The category also recorded average gains of 19.3% and 27.5% in 2012 and 2010, respectively. Real estate fund returns during the odd-numbered years of 2013 and 2011 averaged just 3.6% and 6.5%, however, so the big gains have not been consistent.

Overall, equity-related funds account for the top 12 spots in our updated list of five-year returns for the fund categories. This should not be surprising, given that the bull market was close to celebrating its sixth birthday at press time. Whereas last year’s analysis included the start of the bull market (2009), this year’s analysis only considers calendar years with the bull market fully intact (2010 through 2014). The favorable returns of stocks over this period explains why most bond fund categories rank in the bottom half in terms of performance.

The categories with the best performance are riskier, as would be expected during an extended bull market. The 12 best-performing fund categories have an average total risk index of 1.29. The remaining 33 categories have an average total risk index of 0.86. When stock prices are rising, greater volatility can be an investor’s friend. Notably, the individual best-performing funds over five years were mostly less risky or only slightly more risky than their category peers. The lone exception was Fidelity Select Biotech (FBIOX), whose risk index was 55% higher than the average health care sector fund.

Though the focus of this article is on the best performers, we want to point out the low ranking of energy sector funds (40 out of 45). The category’s five-year annualized performance plunged from 14.6% at the end of 2013 to 1.9% at the end of 2014. The change was the result of a very good year for the category being dropped (energy funds were up by average of 48.0% in 2009) and a bad year being added. Energy funds fell by 18% on average last year in response to the plunge in oil prices. An inherent risk with any fund is the possibility that the favorable conditions of the past will not continue into the future.

Health Care Leads

The four funds that would have given you the highest returns over the past five years are Fidelity Select Biotech (FBIOX), T. Rowe Price Health Sciences (PRHSX), Fidelity Select Health Care (FSPHX) and Janus Global Life Sciences (JAGLX). Each of these funds has five-year annualized gains of 24.8% or higher. Put another way, an investor who bought any of these four funds at the end of 2009 would have tripled his or her investment by the end of 2014.

Though they are all in the health care sector category, each of these funds follows a somewhat different investment strategy. Fidelity Select Biotech, as the name suggests, invests in biotechnology companies. Fidelity Select Health Care targets companies providing medical and medical laboratory products.

T. Rowe Price Health Sciences allocates to pharmaceutical, health care services, medical products and biotechnology companies. Janus Global Life Sciences allows its manager considerable flexibility by treating health care, pharmaceutical, agriculture, cosmetics/personal care and biotechnology companies all as “life sciences” companies.

Though Fidelity Select Biotech is twice as volatile as the average fund covered by our guide, with a total risk index score of 2.22, the price volatility has been to the upside. The fund soared by 65.6% in 2013. Although the risk index covers only 36 months of return data, it may be worth noting that this fund fared comparatively well during the 2007–2009 bear market, losing just 25.4%.

The other three top funds are as risky as or less risky than their health care sector peers. Their total risk indexes are higher, however, because of the volatility of their monthly returns relative to all other mutual funds.

Three Funds Stay On Top

Three mutual funds retained their top-10 rankings from 2014: Matthew 25 MXXVX, Fidelity Select Multimedia (FBMPX) and Fidelity Select Retailing (FSRPX). Matthew 25 and Fidelity Select Retailing also ranked among the top 10 funds in 2013. The strong five-year returns mask what hasn’t always been top performance on a year-by-year basis.

Matthew 25’s inclusion in this year’s top funds reflects the good returns of 2010 through 2013, when it bested its category peers. Last year (2014), the fund lagged, gaining just 5.5% versus 10.8% for the average large-cap fund. As the year-by-year data shows, Matthew 25 has lagged its peers for a total of five out of the last 10 years.

The fund follows a blended growth and value strategy in targeting companies fund manager Mark Mulholland thinks are attractive. Though classified as a large-cap fund, Matthew 25 can hold mid-cap and small-cap stocks. The portfolio is concentrated, with just 42 holdings and more than 60% of the portfolio allocated to the 10 largest positions. Turnover is very low at 7%, implying a buy-and-hold approach. The expense ratio of 1.06% is above average for a large-cap fund, a 2.0% rear load is charged, and the minimum investment is $10,000.

Fidelity Select Multimedia and Fidelity Select Retailing are both categorized as consumer discretionary funds. Fidelity Select Multimedia lagged the category average last year (a return of 8.2% versus 9.1%) after beating the category average in 2013 and 2012. Fidelity Select Retailing beat or matched the category average four out of the last five years.

Fidelity Select Multimedia invests at least 80% of its assets in broadcast- and media-related stocks, under normal market conditions. Nidhi Gupta took over as the fund’s manager in 2013 and quickly moves in and out of stocks, as evident by the portfolio turnover ratio of 111%.

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 41 stocks and also changes its portfolio quickly, with a turnover rate of 72%. Deena Friedman took over as the fund’s manager in July 2014.

These two Fidelity funds have annual expense ratios of 0.81% and 0.83%, respectively, and rear loads of 0.75%. The loads are intended to discourage shareholders from quickly moving in and out of the funds, even though fund managers themselves engage in high levels of portfolio turnover.

Real Estate Breaks Into the Top 10

Baron Real Estate (BREFX) is the first real estate fund to rank among the top 10 since we expanded the list of the best five-year performers from six to 10 in 2013. The fund has a five-year annualized gain of 21.9%. Though categorized as a real estate fund, Baron Real Estate does not strictly invest in real estate investment trusts (REITs). Rather, its manager has considerable latitude, as is evident by the inclusion of senior living facilities, hotels, casinos and a home improvement retailer in its current top holdings.

Baron Real Estate can allocate as much as 25% of its portfolio to international real estate, though the current international allocation is much smaller. We point this out because, while domestic real estate funds have made a comeback, the five-year annualized returns are not as impressive for global real estate funds (16.4% versus 8.5%).

Though the fund beat its category peers during two out the last five years (2012 and 2013), investors should note Baron Real Estate’s limited history. The fund was launched on December 31, 2009. Manager Jeffrey Kolitch also takes large bets, with 43.5% of the fund allocated to its 10 largest holdings.

Fund Listings

Table 2 shows the top 10 funds over five years overall and the top funds 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.

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.

Leveraged Funds Excluded

Ultra, contra and similar leveraged funds are excluded from the top fund listings here. Though funds such as Rydex Dynamic NASDAQ-100 2X Strategy (RYVYX) and ProFunds UltraNASDAQ-100 (UOPIX) have impressive five-year annualized returns (up 34.8% and 34.7%, respectively), they also both plunged by 80% during the last bear market.

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. 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 is a list of the best-performing leveraged funds over the last five years.

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 1.74 for Buffalo Emerging Opportunities (BUFOX) and 1.47 for Walthausen Small Cap Value (WSCVX).

Consistency of performance matters. Glenmede Large Cap Core Portfolio (GTLOX) has ranked among the top large-cap funds during each of the past five years. In contrast, while Fidelity OTC’s (FOCPX) five-year annualized return is only slightly lower (17.8% versus 17.9%), it trailed its category peers in both 2011 and 2012.

Be sure to take the extra step of looking at how long the current manager has been running the fund. For example, Paul D. Greene II took over T. Rowe Price Media & Telecommunications (PRMTX) in May 2013. Though his fund has consistently been among the communications category’s top performers since 2007, the fund’s performance prior to 2013 does not provide much insight as to how Greene will perform in the future. The Table 2 spreadsheet here shows when the current manager for each fund started. We’ll add that several Fidelity funds listed in this article have managers with short tenures.

As previously stated, you should also consider how much risk a fund’s strategy incurs. Matthews India Investor’s (MINDX) category risk index score of 1.55 is more than double that of regional/country stock peer Matthews Asia Small Companies Investment (MSMLX), with a risk score of 0.75. This big difference in risk exists even though the two funds’ five-year returns are not dramatically different: 11.2% versus 9.9%, respectively.

Risk is also relative to the category in which a fund operates. Fidelity Select IT Services Portfolio FBSOX total risk index score of 1.45 may seem high, but the fund’s category risk index of 0.97 shows that it incurs less risk than the average technology sector 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 0.71% expense ratio for domestic balanced fund T. Rowe Price Capital Appreciation (PRWCX) is not comparable to the 1.48% expense ratio for global balanced fund USAA First Start Growth (UFSGX).

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 Utilities (FSUTX), Select Chemicals (FSCHX) and Select Air Transportation (FSAIX) 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 on to 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, Polaris Global Value’s (PGVFX) portfolio turnover ratio is a mere 14% and its tax-cost ratio is 0.4%. To put these numbers into perspective, the average global stock fund has an average turnover rate of 50% and an average tax-cost ratio of 0.9%.

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.

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 similar to those of its peers.

Related

Feature

The Individual Investor’s Guide to the Top Mutual Funds 2015

Related

Exchange-Traded Funds

The Top ETFs Over Three Years: Health Care Takes Top Four Spots

Related

Mutual Funds

Achieving Greater Long-Term Wealth Through Index Funds