Mutual Funds

According to Lipper, the 25 largest mutual fund families manage more than 75% of the industry’s assets; the top 10 companies control 53%, and the biggest 60 oversee nearly 92% of all mutual fund assets. The table below shows the top eight fund companies, as of early 2016 (note: “t” = trillion). BlackRock clearly dominates the field (source: mutualfunddirectory.org).

Largest Mutual Fund Companies  [2016]

There are three taxable events with a mutual fund: (1) sale of securities within the portfolio, (2) the declaration and payment of dividends and/or interest from the portfolio’s securities, and (3) sale of mutual fund shares. Your clients cannot control whether or not a fund is going to sell one or more securities for a profit or loss. Similarly, they cannot stop the payment of dividends and/or interest. The third event is the only one controllable by the shareholder.

Stanford University researchers looked at if and how the number of stocks in a portfolio reduces risk. Their research showed having a two-stock portfolio significantly reduced risk.

A mutual fund’s total costs are measured differently, depending upon the study or expert cited. For example, Kopcke reviewed the 100 largest domestic stock funds owned by defined contribution plans. Kopcke found trading costs averaged 0.11% of assets annually in the quintile with the lowest costs and 1.99% of assets in the quintile with the highest cost, with a median of 0.66%.

All mutual funds buy and sell securities. Securities in an actively managed portfolio may be sold because they are not performing as expected, they no longer fit within the portfolio (e.g., a value stock has appreciated so much it is now considered a growth stock), to free up cash to take advantage of another opportunity or to satisfy shareholder redemptions.

A fund with high costs must perform better than a low-cost fund to generate the same returns for your clients. Even small differences in fees can translate into large differences in returns over time. For example, if you invested $10,000 in a fund with a 10% annual return before expenses with annual operating expenses of 1.5%, you would have ~ $49,725 after 20 years. But if the fund had expenses of only 0.5%, you would end up with $60,858—a 22.4% difference.

An interesting (and better) way to look at return and risk combined is by seeing how an asset category fared over a number of rolling periods. A rolling period includes two or more continuous years and all such periods over the time frame selected. As an example, over any given 10 years, there are eight 3-year rolling periods (1986–1988, 1987–1989, 1988–1990, 1989–1991, etc.). The advantage of using rolling periods is bad returns cannot be hidden as easily. Rolling periods provide an “apples to apples” form of comparison.

The table below shows growth of a $10,000 investment in each of several categories. Notice the disparity between equities and fixed income.

Growth of $10,000  [1972–2016]

FHFA is the federal agency regulating Fannie Mae, Freddie Mac, and 12 Federal Home Loan Banks. The index below represents home sales throughout the U.S. NAREIT is a real estate investment trust trade group. The index is comprised of all publicly traded equity REITs in the U.S.

Home Prices vs. REITs

As advisors, we sometimes forget the basics: a stock represents a fractional ownership interest in a publicly traded corporation. Historically, returns have been higher for owners and partial owners (stocks) than someone who lent money (notes and bonds). Stocks can be characterized by size (capitalization): small cap, medium cap, and large cap. A publicly traded company’s capitalization is calculated by multiplying the price per share by the number of outstanding shares of stock.