As all fund companies will tell you, past performance is no guarantee of future performance. What else, then, is the best way to evaluate mutual funds? After all, an analysis of past performance is all you’ve really got. Isn’t it?
Picking tomorrow’s winners among stock funds may be next to impossible. But picking funds that will win over time, and that suit your investment profile need not be a mystery. Following are a few equity mutual fund characteristics that will help in the process.
■ Fund performance record: Past performance never guarantees anything about the future. And many a great fund seems to go through extended periods of less-than-greatness.
Yet above-average fund performance should certainly indicate managerial capability in some degree. In particular, look for steady performance, year by year. Funds that lead their category over a few months may just be lucky. But funds that have performed in the top half of their category more often than not over a number of years could very well continue to do so — even if they miss for a while.
Look for the year-by-year results on any fund. Relatively strong performance in years when the stock-market indexes decline is an especially endearing quality. Funds that lose money easily, especially in overall bad years, face an uphill battle to make it back.
■ Fund management expenses: Evidence mounts over time that most funds, however strong, tend to see their performance regress to the mean. In other words, after good years come modest ones.
But the size of the management expense ratio (MER) has an ongoing deleterious impact on every fund’s performance.
The MER may seem like a small thing. But it’s one cut-and-dried fund characteristic that drags down any fund’s performance. By emphasizing funds with below average MERs, you improve your odds of getting a superior fund.
Incidentally, since most high-expense funds use some of their management fees to pay trailer fees to mutual-fund dealers, those with the lowest fees often receive little sales support. You’ll have to root them out on your own.
■ Load funds vs no-load funds: We need say little about outright sales charges, be they front-end loads or deferred. Competition seems to makes sales loads obsolete these days. They’re still around, though. But most fund sellers will negotiate them almost out of existence.
■ Management tenure: To inspire real confidence, a fund should have one of two management characteristics. Ideally, a fund’s portfolio manager has been at it for many years. Unfortunately, such situations can be a rare commodity. Those that do exist tend to be at small, manager-owned companies. But large companies, including Fidelity, tend to support their portfolio managers with stable, disciplined research departments that provide continuity of style and management.
■ Fund size: There are times when it’s tempting to pick small funds just because they’re small. A small fund can buy or sell a stock in smaller quantities, without worrying whether or not it’ll move the price. A small fund doesn’t need to find large sellers or buyers to complete transactions. Also, a small fund manager may need only his best ideas. In the hands of an astute manager this is a great asset. Not least, a small holding in a small company that makes a big gain can have an enormous impact on a small fund.
But especially small funds, those with less than about $4 million in assets, expose unit holders to significant risk. They simply can’t diversify very well. And the manager will be easily tempted to overload the fund with a few of his or her best ideas. What’s more, expenses tend to be high in small funds.
On the other hand, large Canadian funds with more than $3 billion in assets, for example, may have difficulty trading without disturbing their own market. These large funds often tend to look more and more like index funds, but with high management fees.
Money Reporter, MPL Communications Inc.
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Money Reporter •8/21/16 •