Winners And Also-Rans Among The Biggest Stock Funds

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Tom Madell
1.44K Followers

Summary

  • The 16 biggest stock funds include nine funds with a load that is sold by broker/advisors, namely American Funds.
  • Funds with a load are almost always more likely to underperform highly similar funds without one.
  • The biggest stock funds over the last five years had extremely high correlations with a fund reflecting the overall stock market and with each other.
  • These high correlations were a result of the fact that stocks tend to move together, either up or down, on a day-to-day basis, suggesting you can own highly correlated funds in an upmarket.

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A huge chunk of fund investor money goes into the largest funds, mostly from the following fund parent companies: American Funds, Fidelity, Vanguard, and T. Rowe Price.

American Funds, if you are unfamiliar with them, are typically sold through brokers/advisors for a fee. You might be surprised to find out, though, that American Funds are among the most widely held among the largest funds.

The table below shows the biggest stock funds, excluding index, foreign, and balanced funds (those which have a considerable portion of assets in bonds), as of about one year ago. Fund expenses shown can include both front-end loads, if any, and expense ratios. Five-year returns shown, when appropriate for American Funds, do reflect loads that are subtracted from investment amounts as they are made, that is, are load adjusted.

Note, however, that these amounts are typically are not included in tables showing investment returns reported by investment sites such as morningstar.com. Therefore, one should only accept as truly accurate, performance tables that say they are load adjusted if the fund charges a load. To their credit, Capital Group, parent of American Funds, does show load-adjusted returns on their Capital Group website, if you click on the tab "Returns with Sales Charge" for a given fund. The Fidelity Mutual Funds Research site also shows load-adjusted returns but only if one carefully scans the fund's entire web page.

As is discussed further below, the extremely high correlations shown in the table between each fund and the largest fund of all, the Vanguard Total Stock Market Index Admiral Fund (VTSAX), composed of a portfolio reflecting the entire US stock market, might suggest each fund is highly similar in composition to that fund. If that is true, there might be no reason to purchase any of these funds, other than VTSAX, especially if they charge a load or had a higher expense ratio than VTSAX's .04%. However, I will offer a different explanation for the high correlations shortly.

Fund (Symbol)

Load

Expense Ratio

5 Year Return

Correlation with VTSAX

-American Funds Growth Fund of Amer A (AGTHX)

5.75%

0.64%

18.81

+0.96

-Invesco QQQ Trust (QQQ)

No

0.20

26.90

+0.91

-Fidelity Contrafund (FCNTX)

No

0.86

21.15

+0.94

-American Funds Washington Mutual A (AWSHX)

5.75

0.58

12.81

+0.98

-American Funds New Perspective (ANWPX)

5.75

0.58

17.01

+0.95

-American Funds Fundamental Invs A (ANCFX)

5.75

0.61

14.10

+0.99

-American Funds Invmt Co of Amer A (AIVSX)

5.75

0.58

12.52

+0.98

-American Funds Capital World Gr & Inc A (CWGIX)

5.75

0.76

11.11

+0.96

-T. Rowe Price Blue Chip Growth (TRBCX)

No

0.68

23.30

+0.93

-American Funds AMCAP A (AMCPX)

5.75

0.68

15.55

: +0.98

-T. Rowe Price Growth Stock (PRGFX)

No

0.64

23.17

+0.94

-Vanguard PRIMECAP Adm (VPMAX)

No

0.31

18.78

+0.97

-American Funds American Mutual A (AMRMX)

5.75

0.59

10.30

+ 0.97

-Dodge & Cox Stock (DODGX)

No

0.52

16.07

: +0.94

-Fidelity Growth Company (FDGRX)

No

0.83

29.61

+0.91

-American Funds SMALLCAP World A (SMCWX)

5.75

1.06

16.77

+0.92

Note: 5 Year Return as of July 31, annualized

Discussion

As can be seen, many investors are still turning to advisors/brokers to help them choose their investments, as is the case when choosing American Funds investments. Thus, as recently as late last year, 9 out of the 16 largest domestic, non-index funds owned by investors were those handled through advisors. These funds, part of the American family of funds, charge an entry fee, or front- end load, of 5.75%. This means that for every $1000 invested, $57.50 of that amount would never reach the fund, but rather, go instead into Capital Group's and the advisor's pocket. As a result, one is down 5.75% on one's investment even before getting started. Since this is a one-time charge, its negative effect on performance gradually lessens over time, but usually amounts to greater than 1% when returns are annualized over 5 years.

Needless to say, American Funds investors must feel they are still getting their money's worth for the advice/assistance they are getting or they wouldn't have made the American Funds among the biggest out there. But at least in terms of the performance shown by these funds over the last five years, the truth is that they have been sacrificing much better performance by settling for these funds.

Here are some obvious facts about fund investing that bear repeating: When you invest in a fund either on your own or through an advisor/broker, you should try to ensure you are really getting your money's worth as compared to other ofttimes similar funds, such as those in the same fund category. Not only should you be getting good returns, comparatively speaking, but loads, if any, should be very low and the funds' expense ratios should be among the lowest available.

Frankly, if you have an advisor and he/she puts you in funds with any sort of loads, you should tell that advisor to find funds without them, or you should get a new advisor. Better yet, chuck having an advisor altogether and invest, on your own, perhaps in almost any one or a combination of the no-load funds listed above. Or, consider investing in a single fund that down through the years tends to do as well or better than the majority of other funds, such as the aforementioned Vanguard Total Stock Market Index Admiral Fund.

While returns in the above funds have been superlative over the last five or more years, no one should assume that they will be anywhere near as generous over the upcoming years. In fact, many experts are predicting rather low returns. While high expenses might appear acceptable if you are still getting a high return as over the last five years, if returns falter, the high fixed expenses will take a proportionally higher bite out of what remains of your returns.

While no one can predict in advance how individual funds will perform, three things that are known right now are the following: 1) How much of the fund and/or any advisor will charge you for ownership of the fund; 2) how closely the fund has performed in the past in relation to other typically readily available funds such as those shown in the above table; and 3) how well has the fund has performed in the past in relation the near-cheapest index fund available, namely VTSAX, or a similar index fund or ETF, that invests in the total U.S. stock market.

Now let's look at how the nine broker/advisor funds have done compared to the other most popular funds listed in the above table. The average load-adjusted annualized return of the nine American Funds was 14.33%. However the average annualized return of the seven no-load funds was 22.71%. Clearly, investors who picked these lower cost no-load funds on their own did better than those who let advisors/brokers put them in much higher total cost, but still highly popular, American Funds. And even investors who chose the most popular index fund, or others like it, did better; VTSAX returned 17.39%.

How to Interpret High Fund Correlations

It might appear that no matter which of these 16 funds you were in, you were essentially getting a highly similar mixture of stocks as contained in the Vanguard fund that consisted of a sampling of all US stocks, namely VTSAX. Of course, correlation tells us the degree of relationship between two factors, such as the height and weight of individuals. Since one would expect that taller people would weigh somewhat more than shorter people, in that case, the correlation would be moderately positive; correlations can vary between +1.00 for positively correlated data sets and -1.00 when the data from two sets of readings are correlated in a negative direction (i.e. a high value in one is associated with a low value in the other).

The correlations shown in the table above compared the daily returns of each fund and the daily returns of VTSAX over the most recent five year period available. If I had included a large table showing the correlation of each of the funds with each of the others, you might be surprised that almost all of the correlations were in the 0.90's as well, showing a very high degree of correlation.

The results might appear to be a flag to investors that regardless of which of these funds chosen, and how high or relatively low their overall cost of ownership is, they might not be getting a fund that is materially different than VTSAX, or from any of the other funds. But examining the returns over that five year period shows that cannot to be the case. Despite the high correlations, there is a wide range of fund results ranging from a high of 29.61 (FDGRX) to a low of 10.30 (AMRMX). Clearly then, the high correlations cannot be showing that each of the funds consist of nearly the same portfolio as VTSAX, or of each other. How then can one explain them?

In order to better understand these high correlations, look at the following pairs of numbers:

Group 1

15

16

17

18

19

20

21

22

23

24

Group 2

5

6

7

8

9

10

11

12

13

14

In spite of the large differences between the numbers in Group 1 compared to Group 2, in this case, the correlation would turn out to be +1.00, the highest possible. Why? Because for every pair of numbers, knowledge of what a number in Group 1 is always predicts exactly what the corresponding Group 2 will be, namely, the number minus 10; that is, the pairs are co-related perfectly to each other.

While fund returns or almost any other set of two numbers are never exactly related to each other, as in this example, the data can be interpreted to show that high correlation alone between two funds does not mean one should always avoid simultaneously owning both of the funds.

Specifically, in the case of these 16 large funds, and including VTSAX, just because two funds have an extremely high correlation, they may not be nearly identical in composition. One would need to actually compare the stocks in each of two fund portfolios to ascertain that. What the high correlations do appear to show is that stocks, in general, tend to move together on a day-to-day basis; this creates a positive relationship between nearly all stock funds. Further, while most stocks may be moving together in the same direction on a given day, some funds may move together in the same direction to a greater degree than another. Thus, on a good day, one stock fund may go up by 1%; a 2nd stock fund also tends to go up but only by 1/2 of a percent.

Thus, Fidelity Growth Company may, with a high degree of regularity, go up twice as much as American Funds Fundamental Invs A. Over an extended period, as this pattern continues, Fidelity Growth Company may outperform American Funds Fundamental Invs A by a factor of about two to one, as shown in the table. And in the same way, even if a fund is highly correlated with the overall stock market, it still may be worth owning, such as the seven funds above that did better than VTSAX. Of course, these seven funds may not do better than the overall stock market in the future.

Investors should keep in mind though that when stock fund returns correlate highly, such as the case for these 17 aforementioned funds, if the overall market turns sour, most of these funds will turn sour as well, and perhaps to an even greater degree. In such an instance, owning funds with a lower correlation with the overall market, or each other, may prove to cushion the fall.

Key Takeaways

  • Funds with any sort of load, or fee taken from your investment, are nearly always a less wise choice than no-load funds.
  • Investing in a broad market index may not always produce the highest return over given periods as compared to popular funds chosen by self-directed investors.
  • Just because there is a high correlation between a fund and a broad market index, or a fund and another fund, does not mean you shouldn't own both.
  • Funds that move together in a highly correlated fashion can reflect that the stocks tend to move in sync on a day-to-day basis but not necessarily to the same degree.

This article was written by

Tom Madell profile picture
1.44K Followers
Tom Madell, Ph.D., is the publisher of Mutual Fund/ETF Research Newsletter, a free newsletter which began publication in 1999 with thousands of readers. It has become one of the most popular mutual fund/ETF newsletters on the internet, as shown here. His site has been named as one of the "Top 12 Investment Newsletters Focusing on Mutual Funds" at mutualfunds.com , an important fund information provider, under "Fund Newsletter". Also, recently his Newsletter was recognized as one of 5 expert mutual fund resources worth following offering free, and, in its case, particularly "unbiased, useful, and original advice" at http://funds-newsletter.com/fundreference-art.htm .He is also a researcher/writer/investor whose articles have appeared on hundreds of websites, including the Wall Street Journal, USA Today, Morningstar and in the international media.His articles have been among the most popular among those posted on the Morningstar.com website by non-Morningstar employed contributors.His recommendations have an outstanding, long-standing record of success . His complete list of former articles can be accessed at http://funds-newsletter.com
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Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: I have a position in VTSAX

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