A roundup of investment news from Morningstar Advisor magazine.
Top Wealth Creators and Destroyers
Total returns are the traditional, and best, measure of a mutual fund's performance. But it can be telling to translate returns into hard dollars, particularly when the amounts at stake are huge. This way, investors can see which strategies are working, particularly on a large scale, and which are not. Open-end mutual fund firms manage more than $7 trillion in assets for U.S. investors (exclusive of money market funds and exchange-traded funds), but how much money have funds made for their shareholders?
To answer that question, Sonya Morris, associate director of fund analysis for institutional products at Morningstar, calculated the total wealth created and destroyed during the course of the decade by focusing on asset growth that wasn't the result of fund flows. The calculation began with total net assets at the end of 1999. Cash flows over the decade were subtracted, and then total net assets at the end of 2009 were deducted.
Results were computed for Morningstar fund categories and the largest 50 funds firms (as measured by total net mutual fund assets). Both existing and extinct funds were included in the calculation, because both contributed to the industry's results during the decade. That's another advantage that dollar totals have--they let investors see which firms and categories have lost money even if they later merge their mistakes away.
The tables below present the top wealth creators and worst wealth destroyers during the decade, along with the asset-weighted returns during that period.
Buy the Unloved, 2010 Style
Since 1994, Morningstar has tracked a strategy named "buy the unloved," which suggests investing in funds from the three most heavily redeemed equity categories from the past 12 months. From 1994 through 2009, the strategy produced an annualized 8.1% return, compared with 6.24% for the S&P 500, 6.96% for the Wilshire 5000, and 5.36% for the MSCI World.
To implement the strategy, an investor buys funds from the three most unloved equity categories and does so again the next year and the year after that. In the year after accumulating three batches of unloved categories, the investor rolls money from the first batch into a new batch so that the holding period is three years.
In the January issue of Morningstar FundInvestor, Russel Kinnel looked at the newest additions to the ranks of the unloved. Based on the 12-month flows through the end of January, the unloved categories to buy now are large-cap growth, large-cap value, and world stock. Kinnel, director of mutual fund research with Morningstar, listed some of his favorite funds to play the unloved strategy.
Among large-growth funds, Primecap Odyssey Growth
Bond Investors Beware of Rising Rates
According to Morningstar research and communications manager Jim Licato, current interest rates are at historical lows in an effort to stimulate consumer spending. The first image below illustrates the rates of bonds with varying maturities (high and low ranges, average, and current) and the federal funds rate since July 1954.
Like stocks, the bond market is also affected by the state of the economy. The interest rates on bonds are affected by the demand for loanable funds. During an economic expansion, the demand for funds tends to cause interest rates to rise, increasing the costs of borrowing. During an economic contraction or recession, the demand for loans is low, and interest rates tend to decline.
Rates will eventually start heading higher; they can't stay at historical lows forever. What can investors expect when this does start to take shape? By analyzing historical bond price and yield data, it might not bode well for fixed-income investors.
Although the bond market has historically been less volatile than the stock market, bonds also fluctuate in price. The second image illustrates the inverse relationship between bond prices and bond yields, or interest rates. When yields for new bonds fall, existing bonds with higher yields become more valuable and can demand a higher price. When yields for new bonds rise, the prices of existing bonds fall to compete with the increased demand for new bonds. If history serves as a guide, when rates start to move upward, bond investors will suffer.
One final point: Bond yields, especially long-term bond yields, are sensitive to inflation expectations because inflation can erode the value of a bond over time. If inflation expectations are high, lenders require a higher interest rate to lend funds for more than the short term. Therefore, if inflation expectations remain high, long-term interest rates may take longer to drop, even during periods when the Fed is cutting rates.
Five Hidden Fund Gems
Russel Kinnel, director of mutual fund research with Morningstar, compiled a list of five funds whose quality is obscured by past failures: