Wouldn’t it be nice if you could count on mutual funds to perform the way they’re supposed to? The great funds would always put up superior numbers; and the lousy ones would be easy to avoid because they would always lag the pack.
Unfortunately, that’s not quite how the world works. Even the most accomplished fund managers run into rough patches. When a fund you own is slogging through one of these performance swamps, it’s often hard to know whether you should persevere or get out.
I won’t pretend I’ve found the magic key that opens all doors. However, there are three factors that, in my experience, can help you decide whether to fire a money manager who seems to have gone cold:
#1 Does the Manager Have a History of Rolling the Dice?
Or, to put it in numbers-talk, has the fund compiled a record of wider price swings than its peers? I’m wary of funds that, over a three-year or five-year period, have posted a substantially higher standard deviation — a measure of price volatility — than their rivals. (You can check the standard deviation of most funds at the Morningstar or Yahoo Finance website.) Fund managers with a high SD tend to be crapshooters who can wipe you out.
#2 How Long Has the Weakness Persisted?
Hundreds of funds performed poorly, in both absolute and relative (to their peers) terms in 2008. That, in itself, wasn’t enough to justify changing horses. If, though, a fund continued to lag its peer group in 2009, something was probably wrong. A second year of laggard performance in 2010 should have closed the case.
#3 What Does the Manager Say About the Mutual Fund’s Strategic Direction?
Study carefully the shareholder reports and any media interviews given by the skipper. It’s OK if a fund manager continues to defend, for a couple of quarters, stock picks that haven’t (yet) worked out. Nobody’s timing is perfect.
Beware, however, of money runners who build enormous positions in stocks or sectors with serious earnings problems. Again, this is a telltale sign of a crapshooter.
3 Mutual Funds to Sell
All right, we’ve got the principles down. Now let’s name some names. Below are three well-known mutual funds that racked up big profits in the 2002–07 bull market but stumbled badly in 2008.
Dodge & Cox Stock Fund (MF: DODGX): This mutual fund took a 43.3% shellacking in 2008, due to heavy overweighting in financial stocks like AIG (NYSE: AIG) and Wachovia. It then beat the S&P 500 in 2009, but lagged slightly in 2010, finally leading again in 2011 (five months).
I’m concerned that DODGX’s management team really hasn’t done much to reduce the fund’s volatility. The portfolio continues to have a pronounced underweight in staples stocks (versus the market) and large holdings in cyclical issues (especially media). Hang on for now, but plan to sell when the market recovers to its April highs.
Fidelity Magellan (MF: FMAGX): Why is Harry Lange still running this fund? Somehow, under his stewardship, this giant ($23 billion assets) fund lost a screaming 49.4% in 2008. Over the past five years, Magellan has chalked up a lower return than the average large-cap growth fund, with 18% larger month-to-month price swings. If a fund is going to take you on a wild ride, at least you should have a fatter wallet to show for it! Sell when the S&P returns to its April peak.
Legg Mason Value Trust (MF: LMVTX): Bill Miller, who piloted the fund to a disastrous 55% loss in 2008, appears to be on his way to retirement. Still, the fund’s weak performance in 2010 and 2011 (through May) suggests that Sam Peters, Miller’s anointed successor, isn’t charting a radically different course. If you’re unlucky enough to own this clunker, sell as soon as the S&P creeps back up to its April high-water mark.
