What a Fund's Investor Returns Are Trying to Tell You
Here are some tips for understanding this new way of looking at fund returns.
Back in October, Morningstar began calculating investor returns for all the mutual funds in our database, alongside the more familiar total returns. What's the difference? A fund's total return tells you how much its portfolio increased or decreased in value over a given period, but its investor return takes inflows and outflows into account to approximate the returns earned by a typical investor. Total return assumes a buy-and-hold strategy, whereas investor return recognizes that investors often buy high and sell low.
To really make sense of investor returns, we need to look at what they mean, especially in relation to a fund's total returns. There's a significant correlation between investor returns and fund volatility, and the difference between investor and total returns can give you clues about how well a fund shop treats its shareholders.
Investor Return Basics
Investor returns, also known as asset-weighted returns, put greater emphasis on periods when a fund is receiving a lot of inflows and its asset base is large, and less emphasis on periods when its asset base is smaller. An overview of our methodology can be found in the fact sheet, and even more details in the nine-page methodology document. (These are PDF files that require Adobe Acrobat.) For a more accessible overview of what investor returns are all about, see Christine Benz's column from when we unveiled them this past November.
You can find any fund's investor returns on Morningstar.com by clicking on "Total Returns" on the left side of the fund's profile, then clicking on the "Investor Returns" tab at the top of the returns page. For example, the investor returns for Vanguard Windsor fund can be found on this page, alongside its total returns. These tables show that Windsor's investor returns have slightly trailed its total returns in most years since 1999, as well as over the trailing one-, three-, five-, and 10-year periods. This indicates that the average investor in Windsor hasn't done quite as well as a pure buy-and-hold investor, which is normal. However, the differences are minor, which isn't surprising, given that the size of the fund's asset base hasn't changed dramatically over the past decade.
On the other hand, if a fund attracts a lot of assets, its performance after the big inflow has a greater impact on its investor returns than its earlier performance, and that can result in significant differences between investor and total returns. For example, investors poured money into technology funds in the late 1990s because of those funds' eye-popping returns, but many of those investors got burned when the tech market crashed hard a few years later. Those funds' 10-year investor returns tend to be much worse than their 10-year total returns, reflecting the fact that their average shareholder didn't do nearly as well as the total returns might imply.
To give one extreme example, the A shares of Munder Internet (MNNAX) had an annualized total return of 6.82% for the trailing 10 years through Nov. 30, better than the specialty-technology category median. However, those same shares had an annualized investor return during the same period of negative 15.78%, among the worst in the category. That dramatic difference results largely from the fund's pattern of asset growth. In 1997, when the fund had just $4.7 million in assets, it gained 30%; in 1998, its asset base rose to $137.5 million, and it gained 98%; and in 1999, its asset base ballooned to an astounding $2.64 billion as it gained 176%. Unfortunately, for all those new shareholders, that's just when the bottom dropped out, as the fund lost 54%, 48%, and 45% in the next three years.
Investor Returns and Volatility
It's no surprise that an Internet fund would have some of the most glaring differences between total returns and investor returns. As Christine Benz noted back in November, the gap between investor returns and total returns tends to become more striking with more volatile groups of funds. Through Nov. 30, the average fund in the specialty-technology category as a whole had a 10-year total return of 6.48% but a 10-year investor return of negative 4.53%, the biggest difference for any category. Other volatile categories such as specialty-communications and Latin America stock also have 10-year investor returns more than 5 percentage points worse than their 10-year total returns. In contrast, less volatile groups, including nearly all bond categories and most categories where funds split their assets between stocks and bonds, had 10-year investor returns only slightly below their total returns. A handful of categories, including foreign large value and inflation-protected bond, actually had better investor returns than total returns. Within categories, too, the more volatile a fund is, the worse its investor returns tend to be relative to its total returns.
That's not to say that it's impossible for a volatile fund to have apparently good investor returns, but in such cases, there are usually extenuating circumstances. For example, Jacob Internet (JAMFX) has a five-year investor return of 32.57% through Nov. 30, significantly better than its annualized total return of 26.01% over the same period. That's largely because of the fund's great recent results, including a 101.3% return in 2003, as its asset base grew from $20 million in 2001 to $95 million in 2006. However, that five-year investor return does not include the fund's huge 79% loss in 2000 or (most of) its 55% decline in 2001, which caused its asset base to plunge and undoubtedly would have made its investor returns look worse than its total returns. Furthermore, the fund's investor return was significantly worse than its total return in 2002, 2004, and 2005, as well as over the trailing three-year and one-year periods. When we look at the whole picture, it appears that this fund's good five-year investor return is an anomaly resulting from an accident of timing.
So should you automatically avoid funds with poor investor returns relative to their total returns? Not necessarily, but poor investor returns can be a red flag that a fund may be too volatile to use to your advantage. After all, if so many other investors have fallen prey to its swings, you too might time your purchases and sales just as poorly. On the flip side, the funds with the best investor returns use prudent, low-risk strategies and place a premium on not losing money.
Investor Returns and Stewardship
Moreover, a fund's investor returns often shed light on the sponsoring firm's stewardship. While a fund company has no direct control over how investors use its funds, it can certainly exert significant influence. Some shops put out lots of trendy funds that tend to attract investors chasing whatever is hot, and otherwise do little to encourage a long-term investment perspective. Those aren't particularly shareholder-friendly trends, and they tend to result in relatively poor shareholder returns, as we saw above in the case of Munder. We don't have a Stewardship Grade for Munder Internet, but there are plenty of examples where poor Stewardship Grades go hand-in-hand with poor investor returns. For example, Seligman Growth (SGRFX) sports a Stewardship Grade of D, including "poor" grades for corporate culture and regulatory issues following a market-timing scandal. The fund's 10-year and five-year investor returns of negative 3.37% and negative 2.11% annually are significantly worse than its corresponding total returns of positive 3.38% and positive 0.18% over the same periods.
On the other hand, most funds with consistently superior investor returns are from shops that encourage long-term investing and discourage short-term trading, in sharp contrast to the likes of Munder Internet. Examples include Brandywine Blue (BLUEX), with a 10-year total return of 8.62% annually and a 10-year investor return of 9.31%, and Dodge & Cox Stock (DODGX), with a 10-year total return of 13.83% annually and a 10-year investor return of 15.04%. Both funds' five-year and one-year investor returns are also better than the corresponding total returns, but their three-year investor returns are slightly worse. Brandywine and Dodge & Cox are known for their shareholder friendliness, and it's no coincidence that both of these funds sport Stewardship Grades of A.
As these examples show, investor returns need to be looked at in the proper context, like any statistic. If you know how to use them, then they can be a very valuable tool for reconstructing a typical investor's experience with a fund and can provide evidence about the type of investor a fund tends to attract.
Join us as we announce the winners of our Fund Manager of the Year and CEO of the Year awards live on CNBC. Christine Benz will announce the fund winners around 10:45 a.m. EST on Wednesday, Jan. 3, 2007. Pat Dorsey will announce the Morningstar CEO of the Year winner around 10:45 a.m. EST on Thursday, Jan. 4, 2007.
David Kathman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.