In an earlier commentary, I explained why it's crucial to gauge a fund's performance history in tandem with the tenure of its managers. Here's the gist: If the manager who earned a fund's five-star rating and Lipper Leader scores is no longer in charge, the fund's track record -- while it may still look good in glossy brochures and print ads -- means next to nothing when applied to its future prospects. A fund is only a strong as the manager running its money.
Theory of relativity
In addition to managerial tenure, there's another companion variable that savvy fund investors should bear in mind when assessing a prospective pick's performance: relative returns.
Comparing a fund with likeminded peers and meaningful benchmarks is absolutely critical if you want to control for "style" -- i.e., where a fund happens to fall on the market-cap and growth/value spectrums. And you do want to control for style -- at least, if you want to make apples-to-apples comparisons.
For the five years that ended Feb. 13, 2006, for example, small-cap value funds as a group have had it all over their bigger, growthier brethren. On average, the typical fund that targets tech behemoths like Intel
Indeed, according to data available from fund tracker Morningstar, the typical small-value fund has bested the average large-growth offering by some 15.8 annualized percentage points over the past five years.
With that in mind, if you looked exclusively at absolute returns, you might be tempted to forget all about the big boys and just grab a bunch of small fries. Bad move. The market moves in cycles; investors eventually gravitate to the most attractive valuations, which means that large caps will eventually have their day in the sun again. Moreover, Foolish fund investors should give their closest scrutiny to categories that are currently out of favor with Wall Street.
That's where relative returns are critical. Gauging how a fund has fared compared with real rivals goes a long way toward separating the keepers from the duds in any asset class.
Get it done
At the end of the day, Job One for smart fund investors is putting together an asset-allocation game plan; Job Two involves slotting the very best picks from among the market's various asset classes into your personalized pie chart.
Champion Funds , the Fool newsletter service that I head up, has you covered on both fronts. As we near our second anniversary, the funds we've recommended have bested the market by more than 10 percentage points, and our model portfolios -- asset-allocation starting points that come in aggressive, moderate, and conservative versions -- are besting their benchmarks, too. If you'd like a sneak peek at our recommended funds and the models -- not to mention our back issues and members-only discussion boards -- click here for a free a 30-day guest pass. So give our service a whirl if you're so inclined, and we'll start finding some apples together.
Shannon Zimmerman doesn't own any of the companies listed. The Fool is investors writing for investors, and you can read all about our disclosure policy by clicking right here.