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What a Difference a Quarter Can Make

When assessing performance, one of the key--but often overlooked--components is the time period under consideration.

Mike Taggart, CFA, 04/06/2012

Much has been made in the financial media about Apple's AAPL contribution to stock market gains over the past three months. Much less highlighted has been the fact that three-year annualized returns have now replaced the dismal first quarter of 2009 with decent (for most securities markets) first-quarter 2012 results. Three-year annualized returns are important, if only because many investors believe that long-term investing requires at least a three-year view. In fact, many of our own, proprietary metrics start with a three-year look-back period. But what is sometimes overlooked is the composition of that three-year time frame.

This is really nothing new. Every rolling period presupposes a "yesterday" and a "tomorrow"--a time frame that rolls off and another that will roll on. However, given the blowout bottom that some markets hit in early 2009, this is a good time to take a look at exactly how the composition of a time period alters the results. This holds true whether or not we are considering a fund's performance, a market trend, or an industry study. This is also why I prefer, when possible, to look at rolling periods over broad swaths of time on a quarterly or monthly basis. We may be able to draw out a couple of other suggestions as well.

Performance is one of the pillars by which we assign our analyst-driven, qualitative, forward-looking Morningstar Analyst Rating. In the methodology document, one of the points we make about performance is: "Trailing returns and calendar-year returns are of interest, but they are insufficient in themselves given end-point dependency in the former case and the arbitrary nature of the latter. We consider many periods and performance aspects to build as comprehensive a picture as possible." The change between three-year annualized performance for the period ended Dec. 31, 2011, and the period ended March 31, 2012, is a good case study for why this point is so important.

Before delving in too quickly, I do want to mention that this exercise only considers funds that were in existence on March 31, 2009, and on March 31, 2012. So, there is survivorship bias. We also are not considering funds with similar portfolios, but we are considering performance relative to other closed-end funds. This is simply because we are making a point about quarterly changes in annualized total return performance and not trying to compare funds against one another for an investment decision.

Below is a table showing the top-performing CEFs based on a three-year annualized period ended March 31, 2012. Typically, when looking at performance, we look at funds with similar holdings, comparing U.S.-equity CEFs with other CEFs, taxable fixed-income CEFs with one another, and so forth. Here, though, we are simply looking at all CEFs because we're not looking at relative performance; we're demonstrating the power of replacing a very bad quarter with a relatively decent quarter.


If you were to rank all 575 U.S.-traded CEFs that have at least a three-year track record, these would be the top 10 funds with the highest three-year annualized total returns on a net asset value basis. Two things jump out. First, half of the funds are real-estate-focused. Someone new to CEFs might look at this list and conclude, incorrectly, that about half of all CEFs are real-estate-focused. In fact, of the 575 CEFs under consideration, only nine are real-estate-focused, and five of them show up--somehow--on this list. That's remarkable. One might conclude that real-estate-focused funds must have had truly great performance, compared with other CEFs at least, over the past several quarters, but they would be wrong.

Mike Taggart, CFA, is the director of closed-end fund research at Morningstar.
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