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Soaring five-year fund returns might not tell the whole story

Sun., March 2, 2014

Fabulous can have a flip side.

It’s something investors should remember as mutual funds’ five-year return figures grow more eye-popping by the day. Many funds have more than doubled over that time, but that’s due in part to the calendar creeping closer to the five-year anniversary of the March 9, 2009, bottom for the market. That means the darkest days of the financial crisis are no longer counted in five-year returns, leaving only the recovery that sent the Standard & Poor’s 500 index to a record high.

The anniversary is a key milestone because many potential investors scrutinize a fund’s five-year record when deciding whether to buy a fund. It’s important, though, to put those stellar performance numbers in context and to temper expectations.

Market conditions are stacked against both stock and bond mutual funds having such strong returns the next five years, analysts say. Plus, some of the funds with the best five-year returns led the pack because they focused on the riskiest investments. Many conservative managers, meanwhile, got left behind in the bull market.

To see how big the numbers are, check the performance of the largest mutual fund by assets. Vanguard’s Total Stock Market Index fund (VTSMX) has a five-year annualized return of 23.2 percent, according to Morningstar. At the end of 2012, its five-year annualized return was 2.2 percent.

A fund’s three- and five-year returns are typically the numbers that average investors find most important, says David Mertens, a principal at Jensen Investment Management. Its mutual funds include Jensen Quality Growth (JENSX), which has Morningstar’s gold medal analyst rating.

Before you invest, here are some key considerations to put that story in perspective:

A REPEAT PERFORMANCE IS DOUBTFUL: Stocks are unlikely to rise as dramatically, in part because they don’t look as cheap as they did in 2009.

This year, analysts forecast earnings per share for S&P 500 companies to rise 7.9 percent.

For bond funds, strategists are more pessimistic given expectations that interest rates will rise from their relatively low levels. Five years ago, the yield on the 10-year Treasury note was 3 percent and on its way down. Falling interest rates help bond mutual funds because they push up prices for existing bonds.

Now, the 10-year Treasury’s yield is below 2.7 percent, but strategists say it’s on its way up.

THE LAST FIVE YEARS HAVE REWARDED RISK: The top-performing stock fund over the last five years has been the Direxion Monthly NASDAQ-100 Bull 2x fund (DXQLX), which has a 60.7 percent annualized return. But it’s not what most people would consider a core investment. The fund is meant more for short-term traders than long-term investors.

It uses leverage in its attempt to double the monthly results of the Nasdaq 100 index, before fees and expenses. While that supercharges gains when the market is strong, it also accelerates losses during downturns. The fund lost 82.8 percent in 2008.

The good news is that investors don’t have to look back too far to see how a fund manager performed in a variety of markets.

Since the late ’90s, stocks have undergone three bull markets (the dot-com boom, the housing bubble and the most recent recovery for stocks) and two bear markets (the dot-com bust and the financial crisis).


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