Mutual funds say ‘bye’ to bad three-year records

BOSTON (MarketWatch) � Mutual funds mark anniversaries to forget the past, not to celebrate it.

With the three-year anniversary of the U.S. stock market�s bottom during the 2008-09 financial crisis passing last week, fund firms have a lot to be joyful about. They can now show off three-year track records that no longer include the 10-month dive that cut the market�s value in half.

Click to Play Chasing income, investors drive up junk-bonds

Before you load up on high-yield �junk� bonds, give them the sniff test first, says Jason Zweig on Mean Street. Photo: Associated Press.

Investors see that market bottom, reached March 9, 2009, as the low point of the worst bear market since the Great Depression. But fund companies think of it as the start of a powerful bull market. It�s something to brag about, with the Dow Jones Industrial Average DJIA �, Standard & Poor�s 500 Index SPX � and the Nasdaq Composite COMP �all up at least 95% since then.

Fund investors must decide how much of the past they want to remember when evaluating their investments, particularly now that three-year results no longer include the market�s darkest days. The anniversary of the bottom also creates a solid measuring point for determining if funds have met expectations.

Time and money

No matter how often management says � and studies prove � that past performance is no indication of future results, investors rely on track records; when a good or bad event falls out of the common viewing window, it changes the impression investors get.

With that in mind, the time period an investor most relies on is crucial, and should depend on the investor�s tolerance for risk.

�Aggressive investors should focus on the past three years; moderate investors should focus on the past five years,� said Mark Salzinger, editor of the No-Load Fund Investor newsletter. �Conservative investors who want equity exposure should focus on 2008, specifically how various equity funds performed that year. That�s because even most equity funds that performed relatively well that year would rise in a bull market, only probably not as much as the market � [which] should be OK for conservative investors.�

Let�s put that to work and see how different some funds look.

We�ll consider two large-cap value funds that appeal to average investors looking for brand-name, core, long-term holdings: American Century Equity Income TWEIX �and T. Rowe Price Equity-Income PRFDX .

The American Century fund has an average annualized gain of 17.3% over the past three years, which isn�t bad until you realize that puts it in the bottom 5% of its peer group, and badly lags the S&P 500�s 25.5% gain, according to investment researcher Morningstar Inc. Yet over the past five years the fund is up 2.8% annualized, standing in the top 15% of its peer group and ahead of the index.

By comparison, the T. Rowe Price fund is up 26% annualized since the market bottomed � dramatically better than the American Century fund and a bit ahead of the S&P 500 � but has gained just 1.4% annualized over the last five years.

Why? The 2008 results. That year, American Century Equity-Income was off just over 20%, compared to a 37% decline in the S&P 500 and a 41.5% loss for the T. Rowe Price fund.

Using Salzinger�s logic, an aggressive investor would be impressed with the T. Rowe Price fund�s results since the market bottomed; the moderate investor is willing to overlook the American Century fund�s dismal relative results over the last three years for its top-shelf performance in the longer time period, including the market meltdown. The conservative investor, again, would side with American Century because it stood up so well.

For investors who want an even longer view � figuring that more market cycles in a track record improves their understanding of a fund�s potential � both funds beat the index and rank near the top of the peer group for the last 10 and 15 years.

Ask experts and they will tell you that the time frame for judging a fund is a personal decision, but you can see through the time-frame games that fund firms play by thinking like a buyer, not an owner.

That being the case, check the three-year performance of your funds to see how well they have recovered since the market bottomed. If they lagged on the way down and haven�t recovered as well as the market, it�s time for a change; just be careful that you are not taking on more risk than you�re comfortable with just to feel like you have a fund that will continue riding the crest of the current upswing.

Said Jeff Tjornehoj, head of Lipper Americas Research: �This isn�t a pass/fail test, it�s an essay. If you�re going to put your wealth in the hands of an active manager beware the near-certainty that they�ll come up short to their benchmark at some point and that it�ll test your faith in them. Then you can ask yourself if you�d buy that fund today if you didn�t already own it; maybe you�ll change your mind, maybe you won�t.�