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How to Turn a 3% Return Into a 10% Gain

Continuing to regularly buy these funds while others were selling would have improved your results during the past five years.

Dan Culloton, 09/26/2013

Would you consider a 10.5% annualized gain a satisfactory investment return for the five years ended Aug. 31, 2013?

Would you believe it if you were told you could have gotten that result from one of the worst-performing and most unpopular large-growth funds of that time period: Fidelity Magellan FMAGX, which posted an anemic 3% annualized, time-weighted gain and watched investors pull nearly $20 billion out during that span?

Would it further shock you to learn that you could have squeezed that performance from the much maligned Magellan by buying it the same month Lehman Brothers imploded, committing to an automatic investment plan, and then doing next to nothing for the next five years?

Moral Victory
It's true. You could have snatched victory, of sorts, from the jaws of defeat by dollar-cost averaging, or making regular periodic investments, into some of the least-loved funds in the industry over the past five years. It's only a "sort of" victory because you still could have done better than many low-ranked, redemption-besieged funds using the same approach with index funds. It's telling, though, how much difference a little perseverance would have made with funds like Magellan.  

Investors, however, have had little patience for actively managed equity funds since the financial crisis. The 10 funds with the biggest outflows in the past five years through August were almost all active equity funds and seven of them had Morningstar Analyst Ratings of Gold, Silver, or Bronze.

Some of the funds on the most-redeemed list have given investors plenty of excuses to leave. Magellan's and Davis NY Venture's NYVTX five-year rankings, for example, are deep in their respective categories' cellars. It's hard to understate the antipathy some investors harbor for these and some of the other most heavily redeemed funds. It's not unusual for Morningstar analysts to hear from disgruntled former shareholders who claim to have owned the offerings for years until they sold at a loss.

That would've been possible with Magellan. Although it was actually up 3% on a time-weighted basis for the five years ended in August, Magellan's Morningstar Investor Returns, which factor in shareholder purchases and sales to estimate the average investor's experience in the fund, show a 2% loss for that period. The fund has been in steady outflows for much of the past decade, but net redemptions reached a five-year high in 2011, just before Magellan gained nearly 18% the following year under a new manager. So, a lot of investors missed on the fund's recent recovery. We don't know where typical Magellan sellers took their business--they could have found a better fund or buried the money in mason jars in the backyard. The evidence shows, however, that fund investors usually hurt themselves with their trades, subtracting about a percentage point from the returns of the average fund. So, it's possible that at least some Magellan investors made a bad situation worse by selling.

What Ifs
That got me thinking: What would happen if investors instead did what they are supposed to do: buy, hold, and dollar-cost average? If the strategy improved investors' results at Magellan, which still gets a Neutral rating because of its long-term mediocrity under a succession of managers, what would it have done for heavily redeemed funds that Morningstar analysts actually recommend?

Dan Culloton is an associate director of fund analysis for Morningstar and editor of Morningstar's Vanguard Fund Family Report, a monthly newsletter that offers independent, no-holds-barred guidance on the pros and cons of this dominant fund family. Click here for a free issue of the Vanguard Fund Family Report.

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