The following article was first purchased at US News and World Report on 1/2/2014.
By Robert Schmansky, CFP®
Funds and returns earned by fund investors tend to suffer after peak performance. Around this time every year, Morningstar releases its selection for the top mutual fund managers of the past year.
However, being selected for this honor may bring investors something similar to the John Madden “curse.” For those who are unfamiliar with the curse, the idea is that whichever athlete is chosen to appear as the face of the famous video game series will suffer poor performance in the following season.
The Morningstar curse doesn’t simply fall on the fund manager who wins. Losing years appear to follow a trend, with recent winners having poor years within the first few years following the award, but they have as many repeat exceptional performances as well.
The more certain curse, in this case, applies not to the mutual fund as much as it applies to the individual investors who decide to jump ship from other funds to the new top skipper.
Below, I look at past fund winners and their total fund returns, as well as investor returns. This measurement, more commonly known as “dollar-weighted returns,” reports the performance the average fund investor received on their investment in the fund. The difference is based on investment flows into and out of the fund over time.
As is the case with many past fund winners, investors who jump into these funds after their award-winning finish appear to have been cursed. Many investors piled in after the good years, only to absorb underperforming years shortly after, their fund often finishing among the worst in its respective category.
2006: O. Mason Hawkins and Staley Cates and Longleaf Partners and Longleaf Partners Small-Cap. Longleaf Partners did not handle the 2007 and 2008 downturn following its award well. In both years, the fund ended in the bottom 10 percent of its category. It did come back, having stellar years in 2009 and 2010, but those who invested at its high would be set back for some time. The small-cap fund is a go-anywhere fund that has landed in several top 10 percent rankings in several categories since the award, which makes it difficult to compare to one single category. This will be a reccurring theme: Like many funds in the small-cap category, it continues its hot streak the year following the award, only to have a dismal year (in the bottom 10 percent) in the next year (2008).
How did investors do? Investor returns in the small-cap fund have been solid, and Longleaf Partners’ record for investors over the past five years also has been great, but extending over 10 years, investors have seen poor performance. The fund’s 10-year investor return rank in its category puts it in the bottom 29 percent. Given that the good five years are included in the 10-year number, investors clearly performed very badly around the time of the Morningstar award.
2007: William Danoff and Fidelity Contrafund and Fidelity Advisor New Insights. I’ll focus on the more popular Contrafund, as investor returns are not available for Advisor New Insights. Although Contrafund has ranked in the top half of large-growth funds and consistently appears to add value, we see similar outperformance in the year following the award, and a dip in the next year. (Though it is mainly currently invested in large-growth stocks, this is a fund that can and does invest outside of this category, which, like Longleaf, makes it difficult to compare directly.) Overall performance over the five years since the award was given has been mediocre, with the fund hovering around the middle of the pack of its category.
How did investors do? Surprisingly well since the award, although returns trailed prior to it. Over the last five years, investors achieved just about the same return as the fund, though they still trail the returns of those who bought and held.
2008: Charlie Dreifus and Royce Special Equity. As a fund, Royce Special Equity trailed the small blend category by 2.31 percentage points annually for the five-year period from 2008 to 2013, and has been in the bottom 20 percent of funds. This includes the award-winning year of 2008, which is telling about the returns over much of the rest of the period.
How did investors do? The five-year investor return rank in the category is in the bottom 18 percent of funds in the category, with investors trailing by about 1.5 percentage points per year.
2009: Bruce Berkowitz and Fairholme Fund. This fund has posted solid returns versus its Morningstar category in most years. Interestingly, in the year following its award, it was the best fund in the large value category, and the year after that, it was the worst fund.
How did investors do? Over the past three years, they are in the absolute bottom few funds, with a loss of 1.11 percent compared to the fund category, which had a 7.55 percent increase in returns.
2010: Bob Goldfarb and David Poppe and Sequoia. Sequoia is another fund that received a solid first place in the year following its selection, and has had middle-of-the-road performance since. The fund invests all over the large-cap universe and holds a significant amount of international equities, so it is difficult to simply compare it to a category. Sequoia was closed to new investors for 25 years, so investors did not have much of a chance to swing in and out, and Morningstar does not track their investor returns.
2011: Scott Satterwhite, James Kieffer and George Sertl and Artisan Mid-Cap Value, Artisan Value and Artisan Small-Cap Value. Since Morningstar does not publish investor returns for these funds, I can’t say if investors followed the curse, but if they did, they are regretting it. The two years following their wins have not been kind to these funds. The Small-Cap Value fund finished in the bottom 10 percent in both years, and performance at the other two funds has been very poor on the whole.
Although the time period for all of these managers is too short to judge them, and they have solid track records before the awards, investors should avoid seeing this award for anything but what it is – a job well done for investors over the past year but not a predictor for future performance.
Robert Schmansky is an independent financial advisor and founder of Clear Financial Advisors in Livonia, Mich. Rob has over a decade of experience in retirement planning and investment strategies.