We all like to believe there is a Holy Grail mutual fund out there that will deliver huge returns year after year without fail. That belief feeds into the marketing of mutual funds—advertisements that sport huge recent returns listed in bold letters lure investors to high-risk funds whose time is often past. It also provides fodder to the publications that run blaring headlines touting the “top ten” funds of the previous year.
Unfortunately, long experience shows that virtually no mutual fund on a hot streak can keep that streak going forever. Usually, just about when the fund’s track record has reached the point that investors take notice, it is already about to lose its touch. Even worse, statistics on flows of money into and out of mutual funds show that the majority of investors plow their money into funds as the funds hit their peaks or have passed their glory days. That means precious few investors ever get the high returns that made the funds famous.
We’ve just gone through another blatant example of this phenomenon. A rush to Internet and technology stocks in the late 1990s propelled new mutual funds that concentrated in those sectors into the stratosphere. By the end of 1999, there were dozens of technology and Internet funds that sported returns in excess of 100% for the previous two years. And they weren’t shy about telling investors how well they had done. Ads run by the Strong Funds were typical. At one point in early 2000, an ad for its Enterprise Fund ran a simple headline that said “Any Questions?” above its recent returns of nearly 148%. Other ads promoted the “new economy” of tech, Internet, and information stocks. Investors who believed in the new economy were rewarded with stunning returns, the ads implied. Meanwhile, few fund companies were advertising their value stock funds, which were suffering through three terrible years of below-market performance. Fund purchase statistics show that billions of dollars were pouring into these hot funds at the end of 1999 and in early 2000, before the NASDAQ stock index—which is dominated by technology stocks—began a dizzying fall in the second quarter of 2000.
How were investors rewarded for jumping into these promising funds? Most got a kick in the pants. For instance, the once famous Kinetics Internet fund, which gained a stunning 835% during the two years ended in December 1999, went on to lose an equally stunning 60% of its value from the beginning of 2000 through Oct. 2001. The lucky investor who got into the then little-known fund in early 1998 and who held on through October of this year managed to earn an excellent 35% annualized return. Most investors weren’t in that early. At the end of 1998 the fund had only $22 million in assets. It was the end of 1999—when the fund had $1.2 billion in assets—that most investors had attempted to join in the fun. Other hot funds saw similar results. Munder NetNet fund gained 444% in 1998 and 1999, only to lose 81% in the 22 months through October. Berger Information Technology delivered a 325% return in the two years through 1999, only to fall by 64% in the subsequent 22 months.
Usually the funds at the top of the charts at any one time are only there because they are riding a short-term wave of high performance within their investment sector. In the late 1990s it was high-tech stocks. In the early 1990s it was large value stocks. In the 1980s it was foreign—especially Japanese—stocks.
Currently, the hot performers are an unlikely group—long-term bond mutual funds. The large and quick decline in interest rates over the last year, coupled with a flight to safety on the part of stock investors, have pushed bond prices up sharply. It is pretty easy to find bond funds that sport 10% to 15% gains over the last year. However, it is unlikely that this trend will continue (and recent indications are it may already be reversing). Interest rates can’t fall much lower. I guess that we’ll just have to wait and see what happens.
Now, I want to share a few thoughts about the contents of this quarterly mailing (for my asset management clients). First, please notice that the account values used to calculate your bill exclude the values of all money market accounts. Second, I have included glossaries for all three reports that I send to asset management clients. If you are a new client (as of this quarter), then you will not start receiving the two performance reports until next quarter. Third, I have included 2001 Realized Gains and Losses reports for some of you. These reports show the net proceeds and cost basis for taxable securities that I sold during 2001. For those of you that use accountants, I have also sent a copy of this report to them. Please feel free to call me if you have any questions about the contents of this quarterly mailing.
In addition, I just want to announce that Keystone Financial Planning will be going online sometime in February of 2002. The website address will be www.KeystoneFP.com. I expect that the website will serve as a valuable resource for both current and prospective clients.
As always, I would encourage you to tell your friends about Keystone Financial Planning. Your referrals are vital to the growth of the firm. Thanks again for being such a great client!
Have a Terrific New Year!
About Christopher Jones
Christopher Jones is the Founder and President of Sparrow Wealth Management, a fee-only financial planning and investment management firm. Before entering the investment field, Chris was a management consultant for Deloitte Monitor. He graduated summa cum laude from Brigham Young University with a B.S. in Economics and a minor in Business Management.