Mutual Funds

Morningstar now has a “forward-looking ranking system to supplement the company’s 1-5 star ratings.” The new system classifies a fund as a gold, silver, bronze, neutral or negative ranking, based on Morningstar’s prediction as to whether or not the fund will outperform its peers in the future.

The division of foreign markets into developed and emerging segments dates back to 1981, when Antoine van Agtmael, an economist at the World Bank, referred to third-world countries as emerging markets. In a 2011 performance study, the Aperio Group looked at 10 years of return data (12/31/2000 to 12/31/2010) from all active emerging markets mutual funds. 

In the typical adoption, a large mutual fund company takes over the management of one or more funds from a smaller firm, retaining the fund’s investment managers as subadvisors. There is usually a cash payment to the smaller firm based on the size of the fund, its track record, and the length of the track record. These “adoptions” are considered a prudent way for a fund family to expand its lineup.

An October 2012 article in The Wall Street Journal (WSJ) recommends the following approach for overseeing a mutual fund:

[1] Set realistic return expectations.

[2] Top managers often have mediocre returns in ~ 3 out of every 10 years.

[3] If a fund falters, give it at least two years to recover.

[4] Large fund inflows may result in poorer returns in the future.

Although rarely discussed, a diversified short-term high-yield bond fund may be the answer for advisors seeking to maximize return while staying somewhat conservative. For example, the Wells Fargo Advantage Short-Term High-Yield Bond Fund lost < 6% while the average high-yield fund was down > 26% in 2008.

Advisors often wonder what to do when a favored mutual fund manager leaves a fund or simply retires. According to studies, when a new manager steps in, subsequent returns are somewhat mixed. For example, an August 2012 study from the University of Rochester shows there is, overall, no difference in returns. However, funds that trailed their benchmarks tended to perform better after the management change—an enhanced performance may likely be due to any fund’s returns that revert to the mean after periods of ups and downs.

The returns on 20-year U.S. Treasurys have been amazing over the past decade (2002-2011) and over the past 30 years (11.03% vs. 0.05% for the S&P 500). This marks the first time that over any given 30-year period, Treasurys outperformed the S&P. For 2011, these long-term bonds had a total return of 28%; for 2008 the total return was 26%. These Treasurys have not seen a better year since 1995.

The division of foreign markets into developed and emerging segments dates back to 1981, when Antoine van Agtmael, an economist at the World Bank, referred to third-world countries as emerging markets. In a 2011 performance study, the Aperio Group looked at 10 years of return data (12/31/2000 to 12/31/2010) from all active emerging markets mutual funds.

“Market neutral” and long-short funds have the objective of protecting investors when the market drops. Management typically engages in short selling (betting stocks are going down) coupled with traditional long-term investments. Whenever you buy a security, you are going “long;” selling “short” is the opposite of going long. Selling short is the selling of a security the seller does not own in the belief it can be bought back at a lower price. The short seller is betting the security is going to later drop in price (when it is bought back by the short seller).

Sometimes referred to as life-cycle funds, target retirement funds are promoted as “one investment choice for a lifetime.” At first glance, all target retirement funds look similar. They consist of a series of funds from the same fund family. Each fund is identified with a specific retirement year, such as 2020 or 2030. The fund managers allocate monies among stocks, bonds, and cash equivalents. As the target date approaches, the composition becomes more conservative, favoring bonds and cash.