Mutual funds come in all shapes and sizes. Some funds charge a lot but perform well, while others charge a little but produce mediocre returns.
However, NerdWallet’s dirty dozen — the 12 worst mutual funds in terms of their five-year annualized return combined with really high management expense ratios — do neither and are to be avoided at all costs.
Headline fees and performance aside, there also are other reasons why these funds aren’t worth a second look — but perhaps best of all, they also show us what to avoid (and even what to look for) in just about any mutual fund:
Acquired Fund Fees
The ALPS/Red Rocks Listed Private Equity Fund (LPEFX) invests in a total of 40 publicly traded private equity companies that invest their capital in privately held businesses. Some of the fund’s largest holdings include KKR & Co. (KKR) and Blackstone Group (BX).
In the past, I’ve written about private equity ETFs, including PowerShares’ Global Listed Private Equity ETF (PSP), which replicates the performance of the Red Rocks Global Listed Private Equity Index. While there’s nothing inherently wrong with investing in private equity, it’s important for investors to understand that the management fees are high in this instance because they include fees the fund pays when investing in other funds. While they’re not directly paid by investors, they nonetheless can affect the performance of the fund.
In the case of LPEFX, the annual expense ratio is 3.28%, with 1.63% coming from acquired fund fees. This means you, the investor, pay 1.65% and the fund pays the rest. With the LPEFX losing 9.45% on an annualized basis over the past five years, it’s clear the acquired fund fees haven’t helped its performance.
Be aware of these fees at all times.
Of NerdWallet’s 12 funds, the only passive fund in the bunch is the Rydex Inverse S&P 500 Strategy (RYUCX), which seeks to replicate the inverse of the daily performance of the S&P 500.
Over the past five years, RYUCX has achieved an annualized return of -12.06% based on annual expense ratio of 2.42%. With the exception of the first year of this study, betting against the index has been a miserable experiment. The SPDR S&P 500 ETF (SPY) since its low in March 2009 has achieved a total cumulative return of 149%.
A worse injustice than its miserable performance is the fact RYUCX charges an annual 12b-1 fee of 1%. The people who sell these funds have to get paid — and they are through this fee. In its prospectus, you’ll see that if you buy the Class A shares — which have a maximum, front-end load sales charge of 4.75% — you would pay $409 less in fees over a 10-year period than the Class C shares. That’s because the A shares’ annual 12b-1 fee is only 0.25%. That adds up across 10 years.
Do not buy mutual funds with 12b-1 fees greater than 0.25% if you can help it.
If I could see the future and told you that the mutual fund you buy today will underperform its benchmark index over the next five years by 340 basis points annually — would you buy it?
I don’t think so.
The DWS Latin America Equity Fund (SLAPX) has achieved an annualized total return of -7% over the past five years through May 21, underperforming the MSCI Emerging Markets Latin America Index by 340 basis points. Comparing apples to apples, the JPMorgan Latin America Fund (JLTCX) outperformed the SLAPX by 436 basis points annually over the past five years — this despite having an expense ratio almost identical to the DWS fund.
So why did the JPMorgan fund do so much better?
Although I’m sure the portfolio managers are very talented men and women, as far as I’m concerned, it all boils down to turnover. JPMorgan’s fund turns over its stocks every couple of years while the DWS fund turns them every seven months. Trading fees can seriously hinder a fund’s performance.
If you’re smart, you’ll limit yourself to funds with turnover rates of 50% or less.
Class A Shares
In Nerd Wallet’s list of the 12 worst mutual funds, it uses just one fund with Class A shares in its example: the ALPS/Red Rocks Listed Private Equity Fund mentioned earlier.
Class A shares have a lower 12b-1 fee, but come with a front-end sales charge where a fee is paid prior to investing your funds, which reduces your net investment. For this reason, many people choose Class B or Class C shares. But that’s a mistake if you’re investing for the long-term, because the lower 12b-1 fee will more than make up for the initial hit at the beginning.
Take the IVY Global Natural Resources Fund (IGNAX), for example. Its Class A shares beat the other two classes over both five- and 10-year periods. Now, the overall result wasn’t pretty — the fund has lost nearly 10% annually in the past five years — but it was 66 basis points higher on an annual basis than its two stablemates.
In addition, IVY — like most fund companies — offers a reduced sales charge based on the amount invested at purchase. For example, if you invested $100,000 in IGNAX, your sales charge would be $4,750, a reduction of $1,000. A purchase of $1 million or more and you’d pay no sales charge. Set up on a sliding scale, future purchases are combined with your original purchases to keep the fee as low as possible in recognition of your continued support of its products.
Do not be afraid of Class A shares. Think of them as you would a higher down payment on a home. The more you put down up front, the less you pay in interest, saving you money in the long run.
As of this writing, Will Ashworth did not hold a position in any of the aforementioned securities.