Value Added


Fund Returns Get Ready to Explode

Steven Goldberg

Don’t be misled, especially by the torrent of ads that will tout stock funds’ five-year results. It’s all due to a quirk in the calendar.



Your stock funds’ five-year returns are getting ready to double. Why? It’s just a matter of the calendar: By December 31, the stock market’s disastrous 37% plunge in 2008 will no longer be part of funds’ five-year records.

SEE ALSO: 5 Stocks Yielding 5% or More

Of course, this calendar quirk won’t put more money in your pocket. To the extent you were in stocks in 2008 or over the entire bear market, which sliced 55.3% from Standard & Poor’s 500-stock index from October 9, 2007, through March 9, 2009, you almost certainly lost money, quite possibly a lot of it.

But dropping ’08 from the five-year figures will make a lot of funds look shinier and more appealing—if you don’t look further back than the past five years. Don’t make that mistake. Please read on.

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Look at how returns can grow. At the end of August, the five-year annualized return for the S&P 500 was 7.3%. If you assume that the market will be absolutely flat from September 1 until the end of this year (an approach I borrowed from Chuck Jaffe at MarketWatch.com), the five-year return for the S&P will swell to an annualized 14.5%. The table below shows returns and projected returns for the 20 largest actively managed stock funds.)

Of course, if the market tanks between now and year’s end, the five-year numbers won’t look quite so pretty. But it’s extremely unlikely that stocks will lose anywhere near as much as they did in the last four months of 2008, when the S&P index surrendered 28.9%. And, assuming that the market doesn’t collapse in early 2014, the five-year returns will continue to swell a while longer because the S&P 500 plunged 25% from the start of 2009 until the market bottomed on March 9 of that year.

The picture is even more dramatic for foreign-stock funds. Assuming that the MSCI EAFE, which tracks mostly large-company stocks in developed nations, is flat between September 1 and the end of 2013, foreign stock funds will look even hotter. The EAFE index returned only 2.1% annualized for the five years that ended August 31. But if the index merely stays flat, the five-year annualized return will balloon to 9.6%.

Returns for emerging-markets funds will also inflate. At the end of August, the MSCI Emerging Markets index had returned an annualized 2.2% over the previous five years. If the index is unchanged for the rest of the year, the five-year annualized return will balloon to 12.9%.

I’m willing to bet that we’re about to get bombarded with ads from mutual fund companies crowing about their funds’ five-year returns.

But savvy investors shouldn’t forget what happened to funds during the cataclysmic 2007-09 bear market. In my view, you learn more about a fund from a bear market than you do from a bull market. It’s nice to own funds that beat the indexes in bull markets. But it’s much more important to own funds that hold up better than the benchmarks in down markets. And the sad fact is that precious few funds can beat the averages in both bull and bear markets. For the most part, you have to pick your poison.

With that in mind, look at the funds in the table below. It’s easy to separate the riskier funds from the safer ones. Dodge & Cox International Stock (symbol DODFX), which lost 62.3%, and Dodge & Cox Stock (DODGX), down 62.1%, top the bear-market losers. That’s a large part of the reason they’re on my avoid list. (In this matter, my views diverge from those of the editors of Kiplinger’s Personal Finance; both funds are members of the Kiplinger 25.)

I think you should be more forgiving of two other big losers among the foreign funds: Harbor International (HAINX), down 57.9%, and Oppenheimer Developing Markets A (ODMAX), off 56.3%, because they lost less than their benchmark indexes. Both are quality funds (although you may have to pay a commission to buy the Oppenheimer fund).

On the positive side, Vanguard Health Care (VGHCX) lost just 35.5%, which not only shows the defensive characteristics of this sector but also speaks well for the fund.

But the two diversified funds that held up best in the bear market, Fidelity Contrafund (FCNTX) and Vanguard Primecap (VPMCX), both off 47.8%, are the real winners here. I don’t know how Fidelity’s Will Danoff continues to put up great numbers with $97 billion in assets, but he does. Similarly, Primecap Management Company, which runs the Vanguard fund, is managing a boatload of money in the same style in several different funds, but it does so superbly.

The bottom line: Stock funds got a true stress test during the bear market. Their sponsors want you to forget those big losses. But in picking funds, this is a number to always keep in mind. Five-year returns are informative, too. But they change, sometimes dramatically, for reasons that have nothing to do with what their managers have done lately.

How 5-Year Returns Will Shift at the 20 Biggest Actively Managed Funds

Name Ticker Annualized through
Aug. 30
Projected annualized return at
end of 2013
Bear market loss*
American Funds Growth Fund of America AAGTHX6.4%15.0%-51.4%
American Funds EuroPacific Growth AAEPGX3.3%10.4%-51.8%
Fidelity ContrafundFCNTX7.8%15.1%-47.8%
American Funds Capital World G/I ACWGIX4.5%11.6%-52.3%
American Funds Washington Mutual AAWSHX7.2%13.6%-53.7%
American Funds Investment Company of America AAIVSX6.5%13.2%-50.6%
American Funds Fundamental Investors AANCFX6.2%14.8%-52.4%
American Funds New Perspective AANWPX6.6%13.7%-50.3%
Fidelity Growth CompanyFDGRX10.2%19.6%-52.0%
Dodge & Cox StockDODGX6.8%16.0%-62.1%
Harbor International InstitutionalHAINX3.5%11.8%-57.9%
Dodge & Cox International StockDODFX3.2%13.1%-62.3%
Vanguard Windsor II InvestorVWNFX7.4%14.4%-56.9%
Fidelity Low-Priced StockFLPSX10.6%18.8%-53.4%
Oppenheimer Developing Markets AODMAX6.2%17.0%-56.3%
T. Rowe Price Growth StockPRGFX8.6%18.1%-51.5%
Vanguard PRIMECAP InvestorVPMCX7.7%15.6%-47.8%
American Funds AMCAP AAMCPX9.4%17.1%-52.5%
BlackRock Equity Dividend Investor BMBDVX5.2%11.6%-50.1%
Vanguard Health Care InvestorVGHCX11.6%15.4%-35.5%

*Cumulative returns Oct. 9, 2007 through March 9, 2009.

Steven T. Goldberg is an investment adviser in the Washington, D.C. area.



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