When it comes to investing in mutual funds, having your confidence shaken can be a good thing.
Checking out a big-name mutual fund owned by my father recently, I was shocked to see that the fund was getting horrible scores from Lipper Inc. And then I saw that the fund – T. Rowe Price Equity Income – had earned a spot as one of the biggest names on “the mutual fund lemon list” issued by newsletter editor Doug Fabian.
Knowing both the fund and its manager, Brian Rogers, reasonably well, I was a bit shocked. I had recommended the fund to my Dad, and about the last place I would have expected to see it was as a laggard on any broad list of funds.
It was time to either confirm my judgment or see if I had made a mistake.
Normally, I’m the one who pushes others into this, by identifying investments that I consider stupid or by having guests on my radio show who suggest that investors bail out of a stock or fund. Being on the receiving end of the jolt served as a good reminder of the right way to review a fund in the context of headlines, ratings services and message-board or talk-show chatter.
The Lipper ratings situation was a shocker until I looked at the date. On Nov. 7, Lipper unveiled its overhauled ratings system; where the firm had always used a 1-to-5 system with “1” representing a “Lipper Leader,” the system was now turned 180 degrees, so that a “5” is now the best grade.
The ratings I saw were accurate, but the accompanying scale was the old one, so instead of being a Lipper Leader for preservation of capital and costs – two key factors in recommending it to my father – the fund appeared to be in the tank on both fronts. When the scale and graphics were fixed, it was easy to see that the fund had not suddenly changed its stripes.
Fabian’s Lemon List was a different story.
Doug Fabian, editor of Successful Investing, creates his list (available at ) using simple criteria; all stock funds that have underperformed appropriate benchmarks for the past one-, three- and five-year periods are branded as lemons. In terms of assets under management, T. Rowe Price Equity Income is the fourth-largest of the lemons, with several popular offerings from Fidelity, Vanguard and a wide range of household names on there too.
Looking at the names of some good funds raised what may be the key question for investors looking at any fund that has drawn a poor rating from any evaluator, namely, “Which benchmark matters more, performance or expectations?”
T. Rowe Price Equity-Income, for example, has an average annualized gain of more than 13 percent over the past five years and rates in the top 25 percent of its Morningstar peer group for the past decade. Manager Rogers, who has been at the helm for 21 years, strives to keep the fund’s yield at least 25 percent higher than that of the S&P 500 Index.
In short, his fund has done precisely what I would have expected when I suggested it to my father.
It’s worth noting that while the fund gets a three-star rating from Morningstar, it remains an “analyst pick” at the firm, further enhancing the idea that sometimes the focus has to be on more than raw returns and quantitative performance measures.
Fabian, for his part, actually agrees, noting that the lemon list is more about helping investors evaluate a fund, to come to the constructive decisions that help them decide what matters most on their own scale. “Not every lemon is a fund that deserves to be sold,” Fabian said, “but they do deserve a second look so that an investor knows what they’ve got and so they can set those personal expectations.”
Chuck Jaffe: cjaffe@marketwatch.com
