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Fund Spy

Beware Easy Explanations for Mutual Fund Performance

Look beneath the surface to learn why a fund is lagging--or leading.

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A few months ago, I discussed various ways that a quick glance at mutual fund portfolios can fool you. For example, a large sector weighting could mislead one into thinking that a fund manager had made a play on a whole area of the market, when in fact the "sector exposure" consisted of a decisive investment in a couple of companies the manager happened to feel strongly about. Country weightings can mislead in similar ways. And it's also important to take care when trying to use fund portfolios as guides for your own stock-picking efforts--for instance, just because a stock shows up at the top of the portfolio doesn't mean the manager loves it right now.

In this follow-up, I'll look at some other ways that reaching judgments based on a too-quick look at a portfolio can prove misleading. By being aware of these pitfalls you can avoid making investment decisions based on faulty assumptions.

As Company Y Goes, So Goes the Portfolio?
Although we like the idea of giving talented managers the freedom to invest heavily in companies they feel most convinced about, we also recognize that such a tactic carries with it a definite risk. Namely, problems with just one or two holdings can have an outsized effect on the fund's performance--unlike the situation at most mutual funds.

Gregg Wolper has a position in the following securities mentioned above: OAKMX. Find out about Morningstar’s editorial policies.