Investors Used These Quality Funds Well

For the past two weeks Five-Star Investor has looked at funds Morningstar's analysts like but which investors have used poorly. We turned the spotlight on funds in which investor return--that is, the real-world experience of average investors in the fund--badly trailed that of the fund itself during the past decade.

Why don't investor returns match those of the funds they own? One of the main culprits is performance-chasing--investors pouring assets into funds with strong recent returns only to find that the funds cannot repeat those performances. This could be because a fund's larger asset base becomes a burden--especially in the small-cap arena--or it could simply be because a fund manager's hot streak begins to cool. Another common theme is investors fleeing funds after steep drops and thereby missing out when funds rebounded.

Although identifying funds in which investor return lagged total return was easy given that it tends to be the norm, finding funds in which investor return topped total return was more challenging. As Russ Kinnel, Morningstar's director of mutual fund research, pointed out in his article Mind the Gap 2011, investor returns tend to lag total returns across all categories with the notable exception of balanced funds, in which investors on average outgained total returns by 30 basis points annually from 2001-10. Kinnel attributes balanced fund investors' strong performance in part to the fact that such funds tend to be "rather dull performers that don't inspire fear or greed."

Among the minority of stock funds in which investor return beat total return during the long haul, it's worth noting that several were closed at some point during the past decade. Fund companies typically close a fund when they believe it has grown too large for the fund's managers to effectively pursue a given strategy, but closings might also have the positive side effect of preventing new investors from chasing returns and flooding the fund with new money at the wrong time. After all, as we've seen when examining funds in which investor return lagged, some investors will flee once-hot funds that experience steep losses.

The following is a sampling of funds our analyst team likes and which investors have used well, which is to say that during the 10-year span ended July 31, investor returns topped total returns.

 Weitz Value (WVALX)
Morningstar Analyst Rating: Silver | 10-Year Annual Total Return: 5.53% | 10-Year Annual Investor Return: 7.46% | Investor/Total Return Gap: 1.93 Points  
Sometimes investors' gut instincts can lead them in the right direction. This fund amassed an asset base of $4.5 billion as of 2004, with investors drawn to fund manager Wally Weitz's contrarian approach. But his decision to bet on out-of-favor sectors such as media and financials while avoiding hot energy stocks contributed to a 3% loss and a 98th percentile performance versus the fund's large-blend peers in 2005 as assets shrank to $3.2 billion. More investors left after the fund's overweighting of financials led to poor performances in 2007 and 2008. By then assets had shrunk to less than $1 billion, where they remain today, with many of the fund's earlier investors jumping ship before things got worse. Fund analyst Kevin McDevitt says the fund is less contrarian today, which might help reduce the impact of costly missteps, and he points to its experienced management team and long-term track record as reasons to recommend it. 

 Heartland Value (HRTVX)
Morningstar Analyst Rating: Bronze | 10-Year Annual Total Return: 9.00% | 10-Year Annual Investor Return: 9.99% | Investor/Total Return Gap: 0.99 Points   
A 70% return in 2003 helped this domestic small-value fund's asset base grow to $2.2 billion, and, despite at or near bottom-decile performances the following two years, it delivered a top 1 percentile performance in 2006. After that, however, its asset base began to wane. It's five-year annualized performance stood at negative 0.1% as of Aug. 3, putting it in the bottom quintile of the small-value category. The fund's 10-year average annual return of 9.3% (as of Aug. 3) puts it near the average for funds in its category and suggests that at least some of the fund's investors left before it began to underperform as today its asset base stands at around $1.1 billion. Analyst Rob Wherry likes the fund's experienced management team and the consistent execution of its valuation-conscious approach.

 Dreyfus Appreciation (DGAGX)
Morningstar Analyst Rating: Silver | 10-Year Annual Total Return: 5.62% | 10-Year Annual Investor Return: 6.53% | Investor/Total Return Gap: 0.91 Points   
It might not be flashy, but this fund's low-volatility, low-turnover approach has served investors well over the long haul. The fund's asset base grew markedly amid top-quartile performances in 2001 and 2002, down years for the market. And even though the fund's 10-year average annual return is roughly in line with that of the S&P 500 index (29 basis points better as of July 31), its steady approach has kept investors from jumping in and out of the fund en masse. Analyst Bridget Hughes says the fund's focus on high-quality companies and its low-risk profile might appeal to investors looking for fairly predictable performance.