Mutual Funds
8 Virtues of Great Funds
What to look for in a mutual fund.
By Jeffrey R. Kosnett, Senior Editor, Kiplinger's Personal Finance
April 2006
- Comments
- Email This Article
- Print This Article
- Order a Reprint
Advertisement
Use these signposts of excellence to judge funds you own as well as those you are considering.
Lusty performance
This is job one: Making money for you. Our favorite funds have total returns (the gain in value of a fund's investments plus reinvested interest and dividends) that are better than the average for their category during most calendar years and over numerous periods, such as three, five and ten years. We're not thrilled when a fund's multiyear return is inflated by one fat year -- a problem with gold and tech funds. We're also unimpressed when a fund boasts of matching an index. Great funds beat comparable indexes.
We do like funds that limit the damage when the market falls but deliver big in good times. Take Marsico Growth (symbol MGRIX), which invests in large, expanding companies. In 2001 and 2002, when its segment of the stock market was performing terribly, Marsico Growth lost much less than most of its rivals and Standard & Poor's 500-stock index. Since the stock market started to recover, Marsico has outgained the S&P 500 and the large-growth-fund category, just as it did during the 1990s bull market.
Management excellence
Outstanding records don't happen by accident. They are the work of talented men, women and sometimes teams. Favor funds with good records whose managers have been at the helm five or even ten years. Or follow an established manager from a large fund firm who launches his or her own organization, so you get a proven manager even if the fund is new.
Most great managers have well-defined investment philosophies, are committed to their jobs and exhibit an infectious enthusiasm. Plus, they don't let their funds fall apart. Once someone becomes synonymous with success, such as Bill Miller of Legg Mason Value Trust, Bill Nygren of Oakmark, Chris Davis of Selected American Shares or Will Danoff of Fidelity Contrafund, he or she occupies the same exalted perch as a renowned chef. Everyone wants to enjoy what they offer -- but they're constantly on the spot. If their establishment goes downhill, so does their reputation. So although all managers stumble from time to time, the best ones work harder to recover.
Low costs and expenses
Mutual funds charge two types of fees: a "load" for sales and marketing and an "expense ratio" for managing assets. If you choose your own funds, you should stick with no-load fund companies.
All funds come with expense ratios, and the lower, the better, because those expenses come right out of your assets. For a non-index fund that invests in U.S. stocks, 1.25% is the high side of reasonable, and anything below 1% is a good deal. Foreign stocks cost more to research, manage and trade, so in that category, you'll normally face higher expenses. But you don't have to give up too much return in fees and charges. Dodge & Cox International, one of the best international funds, costs a mere 0.77%, less than half the cost of some other good international funds and below the average for stock funds of any kind. Index funds, which aren't actively managed, get a huge boost in performance thanks to their low expenses.
A svelte profile
A good track record can be an invitation to self-destruction. New money from investors piles in, until at some point the sheer size of the fund's asset base begins to chip away at its success. The manager runs out of really good ideas and resorts to not-so-good ones. Trading costs escalate when the fund builds and sells huge positions in companies. There's really no cure and only one preventative for mutual fund elephantitis: Close the fund before assets overwhelm the manager.
It's impossible to say exactly what size is appropriate. A fund that invests in large growth companies, such as General Electric and Procter & Gamble, can handle $10 billion or more. But with small companies, or in a narrow area such as health care, $1 billion can be too much to manage. If a fund's results lag its category more than one year, or cash levels build, it could be a case of bloat. Fund companies that closely align themselves with shareholders -- among them Wasatch and Bridgeway -- don't wait for those telltale signs before closing the door to new investors.
