- Investors are apparently not very good at picking winning mutual funds or ETFs since their most popular choices tend to underperform.
- ETF investors' choices when held for the longer term perform more poorly than mutual fund investors' choices.
- ETF investors in particular may tend to pick sub-categories within the stock and bond markets that while perhaps appealing at the time turn out "not the best places to be".
- Investors can seek out investment companies whose offerings show a majority of market-beating ETFs/funds as compared to those popular funds frequently selected by investors.
In this article, I will show that the funds and ETFs most frequently chosen by investors do not, on average, have a particularly good long-term track record as compared to randomly chosen funds. In fact, over the last five years, investors could have achieved better returns instead by using a rather surprisingly simple method. This method will be described shortly.
If we roughly define those funds with the most investor assets as those most chosen by investors, we can then examine how well these choices have done down the road. Conveniently, every month, a list of the funds with the most investor assets is published in the Wall Street Journal. You can also find similar lists elsewhere online.
Let's look at the biggest stock and bond mutual funds and ETFs that investors were choosing five years ago. While not all investors will hold their chosen funds for that long, I found quite similar results to those discussed here when looking at investors' choices made just one year ago.
Stock Mutual Funds
Just over five years ago, investors had the most money in the following 25 stock mutual funds below, listed in order of assets under management (funds that are stock/bond combinations were excluded; ETFs are covered separately below).
The table also shows how well each fund performed over the following five years. As you scan the table, keep in mind that over the same period, the S&P 500 index with dividends reinvested, returned 23.00% (annualized) while the average return of all domestic diversified funds as reported in the Wall Street Journal was 22.30%.
|Stock Mutual Funds with Most Assets, Mar. 2009||Stock Mutual Funds with Most Assets, Mar. 2009 (cont.)|
|AGTHX||21.99%||American Funds Growth Fund of Amer A||DODFX||22.72||Dodge & Cox International Stock|
|FCNTX||22.66||Fidelity Contrafund||FDGRX||27.20||Fidelity Growth Company|
|CWGIX||19.09||American Funds Capital World G/I A||VFIAX*||23.00||Vanguard 500 Index Admiral|
|AIVSX||20.49||American Funds Invmt Co of Amer A||VTSAX*||24.00||Vanguard Total Stock Mkt Idx Adm|
|VTSMX*||23.85||Vanguard Total Stock Mkt Idx Inv||FMAGX||22.03||Fidelity Magellan|
|VFINX*||22.85||Vanguard 500 Index Inv||FLPSX||25.95||Fidelity Low-Priced Stock|
|AWSHX||21.72||American Funds Washington Mutual A||VIIIX*||23.03||Vanguard Institutional Index Instl Pl|
|AEPGX||17.37||American Funds EuroPacific Gr A||VWNFX||22.62||Vanguard Windsor II Inv|
|VINIX*||23.00||Vanguard Institutional Index I||VGTSX||17.34||Vanguard Total Intl Stock Index Inv|
|DODGX||25.93||Dodge & Cox Stock||NYVTX||22.16||Davis NY Venture A|
|ANWPX||20.94||American Funds New Perspective A||GFAFX||21.99||American Funds Growth Fund of Amer F1|
|FDIVX||18.02||Fidelity Diversified International||FEQIX||22.15||Fidelity Equity-Income|
|ANCFX||21.78||American Funds Fundamental Invs A|
Note: Funds in tables with an "*" aim to match the S&P 500 or an index of the total US stock market; all data thru 2-28.
Only six out of the 25 funds, highlighted in bold, or 24%, that investors most chose 5 years ago wound up beating the S&P 500 on a long-term basis, with 76% trailing the index. Of those six, 3 were index funds constructed to closely resemble the index or an index of the total US stock market. And 5 out of these six were either Vanguard or Fidelity funds. The remaining funds were nearly all managed funds that tended to trail the index by up to several percentage points, many of them American Funds that charge a hefty load.
The average performance for the 25 funds was 22.16%, slightly trailing the performance for all US diversified funds. In other words, the masses of investors' money, at least in terms of the most popular funds in early 2009, did no better (and actually, a tad worse) than the average fund which investors could hit upon by randomly selecting from the pool of all available US stock mutual funds.
True, many investors will not likely lament the above outsized returns of the last 5 years even if they did fall short of the more than 23% annualized returns achieved by the six funds shown that excelled. However, trailing the index by 1 or 2 or more percent per year can amount to a significant amount of money year after year. And if returns over the coming years fall back to something closer to, say, 8-10% per year, such a deficit would represent a significant percentage of one's overall return.
You might think that investors who chose ETFs 5 years ago would have made more savvy choices than those who picked mutual funds. After all, many knowledgeable investors argue that ETFs, rather than mutual funds, are better choices for investors.
The following table shows the 25 ETFs investors had the most money in five years ago, listed in order of assets under management. The table also shows how well each fund's market price performed over the following five years. Once again, keep in mind the 23.00% annualized return for the S&P 500 and 22.30% for the average mutual fund over the same period.
|Stock ETFs with Most Assets, Mar. 2009||Stock ETFs with Most Assets, Mar. 2009 (cont.)|
|(NYSEARCA:SPY)*||22.86%||SPDR S&P 500||(NYSEARCA:MDY)||26.44||SPDR S&P MidCap 400|
|(NYSEARCA:GLD)||6.62||SPDR Gold Shares||(NYSEARCA:IVW)||22.91||iShares S&P 500 Growth|
|(NYSEARCA:EFA)||17.73||iShares MSCI EAFE||(NYSEARCA:EWZ)||7.06||iShares MSCI Brazil Capped|
|(NYSEARCA:EEM)||15.28||iShares MSCI Emerging Markets||(NYSEARCA:GDX)||-4.35||Market Vectors Gold Miners|
|(NYSEARCA:IVV)*||22.85||iShares Core S&P 500||(NYSEARCA:XLE)||18.41||Energy Select Sector SPDR|
|(NASDAQ:QQQ)||28.09||PowerShares QQQ||(NYSEARCA:XLF)||25.36||Financial Select Sector SPDR|
|(NYSEARCA:IWF)||23.83||iShares Russell 1000 Growth||(NYSEARCA:EWJ)||11.29||iShares MSCI Japan|
|(NYSEARCA:VTI)*||23.98||Vanguard Total Stock Market||(NYSEARCA:IWB)||23.41||iShares Russell 1000|
|(NYSEARCA:IWM)||26.49||iShares Russell 2000||(NYSEARCA:IJH)||26.68||iShares Core S&P Mid-Cap|
|(NYSEARCA:DIA)||21.24||SPDR Dow Jones Industrial Average||(NYSEARCA:SLV)||9.58||iShares Silver Trust|
|(NYSEARCA:IWD)||22.86||iShares Russell 1000 Value||(NYSEARCA:IWR)||27.60||iShares Russell Mid-Cap|
|(NYSEARCA:FXI)||10.10||iShares China Large-Cap||(NYSEARCA:SSO)||44.01||ProShares Ultra S&P500|
|(NYSEARCA:VWO)||16.20||Vanguard Emerging Markets Stock Idx|
For the most popular ETFs of five years ago, 60% of the most chosen wound up trailing the S&P 500, while 40% were ahead. While this 40% exceeded the 24% for mutual funds, you can see that, overall, these ETFs' performance results tended to be more variable than the above 25 stock mutual funds. In fact, as a group, the average performance for the most popular ETFs was 19.86%, trailing the average for the popular mutual funds by 2.40%.
Clearly, investors on average in the biggest ETFs five years ago who held their investments through this half decade of a super bull market would have had a more mixed record of excelling and would have done more poorly than the mutual fund investors in relative terms. And although only a scant few of these investors could complain about their absolute performance, it might be surprising that the most popular ETFs of five years ago did not prove to be a more winning place to be for either savvy or ordinary investors who began flocking to these investment products in recent years while, at the same time, pulling back from mutual funds.
In all honesty, likely there was nothing wrong per se with these ETFs. Rather, by directing their choices at times to more narrow corners of the stock market, such as precious metals and more volatile foreign markets, some ETF investors wound up choosing areas that turned out not "the best places to be" over a significant period of time.
Bond Mutual Funds
Likewise, 5 years ago, investors had the most money in the bond mutual funds shown below listed in order of assets under management. In evaluating these funds' performances over the next 5 years, keep in mind that the average taxable bond fund returned 7.78% annualized through 2-28-14, as reported in the Wall Street Journal.
|Bond Mutual Funds with Most Assets, Mar. 2009||Bond Mutual Funds with Most Assets, Mar. 2009 (cont.)|
|PTTRX||7.37%||PIMCO Total Return Instl||VIPSX||5.98||Vanguard Inflation-Protected Secs Inv|
|PTRAX||7.10||PIMCO Total Return Admin||VFSUX||5.21||Vanguard Sh-Term Investment-Grade Adm|
|ABNDX||7.13||American Funds Bond Fund of Amer A||FBNDX||7.70||Fidelity Investment Grade Bond|
|PTTAX||6.92||PIMCO Total Return A||FTBFX||8.34||Fidelity Total Bond|
|VBMFX||4.90||Vanguard Total Bond Market Index Inv||PTTDX||7.10||PIMCO Total Return D|
|VFIJX||4.47||Vanguard GNMA Adm||VBTSX||5.05||Vanguard Total Bond Market Index Signal|
|VFIIX||4.36||Vanguard GNMA Inv||LSBDX||15.49||Loomis Sayles Bond Instl|
|DODIX||7.85||Dodge & Cox Income||PTLDX||5.56||PIMCO Low Duration Instl|
|VBTLX||5.05||Vanguard Total Bond Market Index Adm||AHITX||16.66||American Funds American Hi Inc Tr A|
|VTBIX||4.91||Vanguard Total Bond Market II Idx Inv||PRCIX||6.22||T. Rowe Price New Income|
|VBTIX||5.08||Vanguard Total Bond Market Index I||OIBAX||6.98||Oppenheimer International Bond A|
|VFSTX||5.10||Vanguard Sh-Term Investment-Grade Inv||WACPX||11.57||Western Asset Core Plus Bond I|
|FBIDX||4.93||Fidelity Spartan US Bond Idx Investor|
Only 5 out of 25, or 20%, of the most popular mutual funds in terms of invested assets in early 2009 wound up outperforming the average bond fund after 5 years, while 80% trailed. The average annualized performance of these funds over the period was 6.06%. Here, the outperforming funds were from a variety of fund families, and noticeably, none from Vanguard.
While you might wonder why the average bond fund did so well as compared to many of the funds above and to the bond benchmark (typically, the AGG ETF shown in the table below), the reason appears to be that corporate and high yielding bond funds, of which there are many in the universe of bond funds, tended to excel. On the other hand, many "safety-oriented" investors preferred funds that had a higher proportion invested in government bonds which, while less risky, tended to underperform over the last 5 years.
The final table shows the 10 bond ETFs where investors had the most money 5 years ago. (Only 10 are listed since in 2009, even among the "biggest" bond ETFs, many were small as compared to big bond ETFs today.)
|Bond ETFs with Most Assets, Mar. 2009||Bond ETFs with Most Assets, Mar. 2009 (cont.)|
|5 Yr. Tot.|
|5 Yr. Tot.|
|(NYSEARCA:TIP)||5.99%||iShares TIPS Bond ETF||(NYSEARCA:IEF)||4.51||iShares 7-10 Year Treasury Bond|
|(NYSEARCA:AGG)||4.74||iShares Core Total US Bond Market||(NYSEARCA:HYG)||15.82||iShares iBoxx $ High Yield Corp.|
|(NYSEARCA:LQD)||9.31||iShares iBoxx $ Investment Grade C||(NYSEARCA:SHV)||0.10||iShares Short Treasury Bond ETF|
|(NYSEARCA:SHY)||1.08||iShares 1-3 Year Treasury Bond ETF||(NYSEARCA:TLT)||4.86||iShares 20+ Year Treasury Bond|
|(NYSEARCA:BND)||4.83||Vanguard Total Bond Market||(NYSEARCA:BSV)||2.66||Vanguard Short-Term Bond|
As with the most popular bond mutual funds, only 20% or 2 out of the 10, outperformed the average bond mutual fund. The average return for these ETFs was 5.39% annualized which was, once again, less than the returns for either the most popular bond mutual funds or even the average of all taxable bond mutual funds.
The same reasons as for popular stock ETF underperformance appear to apply for bond ETF investors. Rather than choosing investments that tended to allow a manager pick a relatively broader swath of bond investments, ETF investors often chose to invest in a narrower band of bond market segments. Over the subsequent half decade, the segments chosen by the ETF investors, while perhaps appealing at the time, once again did not prove the best places to be. In many cases, good bond fund managers (vs. narrower indexes) were able to guide their funds' investments into more profitable directions as conditions changed.
Why Do So Many Investors Wind Up in Market-Lagging Funds?
Many of the most popular funds chosen by investors are from a slate of offerings from the largest fund providers which include, at the top of the list, Fidelity, Vanguard, and American Funds. And Fidelity and Vanguard are among the biggest providers of 401(k)s which therefore include a number of their own funds in the list of funds available within the ensemble. Meanwhile, American Funds are distributed widely by investment advisors and brokers.
But beyond high availability and visibility, many investors perhaps choose these mainstream funds because they have more confidence in well-known funds that in the past have had pretty good track records.
But, as shown by the data above, the most popular funds often do not wind up being better choices, and often worse choices, than perhaps those that could have been chosen merely by throwing darts at a listing of all funds.
At the start of this article, I suggested a surprisingly simple method of selecting funds that had a better chance of beating the average fund, or better yet, even the market indexes. This method is suggested by using the same kind of data analysis as is provided above. That is, from a pool of potential selections, we looked at those which would have beaten the average fund, and even the stock and bond benchmarks as well.
As you likely are aware, both Vanguard, Fidelity, and a few other investment companies are known as providing a very good overall slate of funds. But here, let's just focus on these two fund giants; if interested, you can check out the comparative performance of other fund company slates on your own.
Starting with Vanguard, if you look at Vanguard's total lineup of stock funds you will see a much larger percentage of these funds beat the S&P 500 index or the average fund than the data shown above.
In fact, 29 out of 48 Vanguard stock funds that have existed for the entire 5 years returned greater than 23% annualized over the last 5 years - or 60% (This includes "Investor" share class shares only to avoid repetition with additional share classes.)
Likewise, if you look at Fidelity's much bigger lineup of stock funds, you will see that out of 115 funds listed on their website with 5 year track records, 65 beat the index, or almost 57% (excludes commodity, alternative fund categories, and a myriad of Fidelity additional share classes).
For stock ETFs, Vanguard had 19 out of 33, or about 58%, which beat the index. (Note though that Fidelity only has 10 ETFs of its own and none have a 5 year track record yet; they instead offer hundreds of iShares ETFs.)
With bonds, the story may not be quite as clear. Vanguard had 4 out of 14 bond funds (excluding munis) or 29% beating the return of the average fund shown above, vs. the 20% for the most popular funds that were chosen by investors. Fidelity had 7 out of 25 funds, or 28%, with 5 year records beating the average fund.
Given these more favorable odds of success, if you have access to these Vanguard or Fidelity funds as listed on their respective websites, it might make more sense to pick almost any fund from these slates rather just the best known funds, or other well-known funds from other fund companies. Of course, one should always exercise care in selecting one's specific choices.
But what if investors are locked into qualified plans such as 401(k)s that do not offer choices from these two best known fund families?
With stocks, perhaps most should invest in funds that mirror S&P index itself, or a fund that invests in the total U.S. market rather than attempting to pick from less diversified offerings that are often found in funds that focus on certain types of assets, sectors, or in many specialized ETFs. With bonds, perhaps they should search for managed funds that allow the manager to select and occasionally reshuffle which areas of the bond market to keep the most assets in, rather than for funds that prescribe a relatively fixed investment position. Finally, perhaps they should be sure to do some research to see which managed funds have outperforming track records over the last 5 years (or better still, even more), preferably achieved by the same on-going manager.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.