Did You Do as Well as Your Fund?
While funds such as CGM Focus and Fairholme have raked in assets, many of their investors are late to the party.
Fund Spy
It's common practice to look at a fund's total return number for a snapshot of what performance to expect, but that won't give you the full picture. Morningstar studies have shown that investors' actual gains frequently pale in comparison to reported total return numbers. This phenomenon frequently plays out among funds that attract assets after streaks of hot performance, only to see some investors get skittish at the first signs of underperformance.
To get a sense of how investors in a fund have really fared, look to Investor Returns. As Christine Benz, Morningstar's personal finance director, explained in a 2006 article (written shortly after we launched Investor Returns data), Investor Returns factor in the timing of investors' purchases and sales to depict the returns earned by the typical investor. A fund's Investor Return takes into account the fact that not all of its investors bought shares at the beginning of a period and held them until the end. Benz provides a simple example: Assume a fund generated a 10% total return in a calendar year, with most of those gains coming in the year's first quarter. If investors added substantial sums of money to the fund after its first-quarter runup, the fund's Investor Returns for that year would be lower than the fund's 10% total return.
To find a fund's Investor Returns, click on the Performance tab at the top of the fund's profile, and then click "Investor Returns."
Higher Volatility, Lower Investor Return
Morningstar has found that volatile funds (often focused on one sector) tend to have the greatest discrepancies between total returns and Investor Returns. This correlation makes sense: Volatile funds may entice investors on the upswing, but spook them into withdrawing during rough patches. So, investors in volatile funds can unwittingly end up buying high and selling low. Comparing Investor Returns to total returns can help you identify volatile funds where this has been an issue. This isn't to say you should never invest in a fund with a comparably low Investor Return, but you should be prepared to ride out the rough spots.
But it's not just volatile sector funds that suffer from this problem: In fact, funds such as CGM Focus and Fairholme, both investor darlings in recent times, are victims, too.
These funds have impressive total return numbers, but many investors didn't see them in their wallets, as indicated by the discrepancies between total returns and Investor Returns as of July 31, 2009:
CGM Focus' trailing 10-year return suggests that a $10,000 investment a decade ago would now be worth $51,633. The fund's trailing 10-year Investor Return over that span, however, suggests that the same $10,000 shriveled to $1,585! The difference--all $50,048 worth--is attributable to investors' repeatedly mistiming their purchases and sales in chasing performance.
Meanwhile, at Fairholme, $10,000 invested in the fund five years ago would now be worth $15,078.19--a more than 50% gain. However, the Investor Return shows that the typical investor actually lost money over the last five years, with a $10,000 investment now worth $9,187.75 to the typical investor because most arrived after the strong performance only to experience last year's downdraft.
Losing More than You Think?
It's not simply a matter of missing out on gains. Investor Returns also show that investors can magnify their losses when the fund does poorly.
In Schneider Value's case, the total return would suggest a loss of $1,825 for $10,000 invested at the beginning of the period, resulting in an ending value of $8,175. Typical investors lost more than that, however: Using Investor Returns, the $10,000 shrinks to $3,539.
Of course, all this isn't to say you should never invest in a fund with a comparably low Investor Return. Rather, it again reinforces the point that chasing performance is an exercise in futility. Even if you're investing in solid offerings such as Fairholme, doing so just to chase returns probably won't get you a desirable result.
To learn more about Investor Returns, read mutual fund analyst David Kathman's discussion of what these numbers are trying to tell you. You can find more detail on how we calculate Investor Returns in this fact sheet (pdf).