Lately, investors aren't bragging about the size of their returns. Rather, they're bragging about how minimal their losses have been.
That is, unless they have top-notch mutual funds anchoring their portfolio.
Quality mutual funds are able to stand up well even during these market dips. However, the worst investment out there is a bad mutual fund -- because not only does it underperform the market, it charges you outrageous fees these for these poor results.
For example, I'd like to highlight a fund that has delivered impressive returns this year, but has set itself up disastrously for the long term.
Without further ado
The fund in question is Shepherd Large Cap Growth Fund (DOIGX), which year to date has impressively outperformed the market by nearly seven percentage points. This success is due, in large part, to holdings such as Potash Corp. of Saskatchewan
But examine these statistics and count the transgressions:
|
Front Load: |
4.75% |
|
Expense Ratio: |
2.25% |
|
10-Year Annualized Return*: |
-0.83% |
Yes, you read that correctly. If you bought this fund 10 years ago, you would have lost money. That doesn't factor in the heinous expenses and the effects of inflation -- about 3% annually.
In simple terms: this fund stinks.
Though I admit, it'd be easy to quickly glance at its recent performance and believe that this is a great choice. But digging a little deeper, the rotten interior of this fund becomes evident.
In fact, savvy investors could have predicted this fund's inevitable long-term failure for several reasons:
- High front load and expense ratio.
- Poor long-term performance.
- Evidence of style drift.
Loading up the manager's pockets
The fees you pay to invest will, over time, hurt the growth of your portfolio, which is why it's so important to keep a lid on them.
With the high front-end load (the amount you pay the managers just to let them invest your money), $5,000 of your hard-earned money would immediately be reduced to just over $4,700.
As if that wasn't enough, they'll charge you additional 2.25% every year to continue to invest for you. Now you're down to about $4,650 (meaning a 7% capital loss) -- and that's before we factor in performance losses!
Needless to say, it makes most sense to minimize your fees. We recommend no-load funds and expense ratios below the average 1.5% for this very reason.
Performance avoiding
We Fools aren't cool with the idea that past performance is any guarantee of future success (or failure, for that matter), but when a fund has underperformed in both bull markets and bear, it's a great indication to look the other way.
Observe this fund's dismal performance over the past seven years compared with the Vanguard 500 Index, which tracks the S&P 500 and is heavily weighted toward large caps such as ExxonMobil
|
Year |
Fund Total Return |
+/- VFINX |
|---|---|---|
|
2000 |
-27.3% |
-18.2 |
|
2001 |
-43.4% |
-31.5 |
|
2002 |
-37.2% |
-15.1 |
|
2003 |
25.2% |
-3.5 |
|
2004 |
-1.9% |
-12.86 |
|
2005 |
12.5% |
+7.6 |
|
2006 |
7.6% |
-8.2 |
This fund lagged the market in every year but one -- often with double-digit underperformance. Although we believe that the past isn't always an indication of future results, you should still avoid this fund.
Changes in style
Style drift occurs when a fund manager changes the initial strategy to seek out better returns. Performance chasing is never a sound strategy.
But that is exactly what Shepherd Large Cap Growth has done. While it's a self-identified "Large Cap Growth" fund, it's more of a mid-cap fund nowadays. Its average market cap is $11 billion, and nearly half of its assets are in medium-cap companies, according to Morningstar.
So if you gave them your money when you first devised an asset-allocation plan, hoping to achieve the success of large-cap stocks, you'd be sorely disappointed to find out where your money lies.
One caveat
The Shepherd fund invests based on moral values. You won't see this fund piling assets into companies that it deems unethical. That's certainly a laudable mission, but with such high fees, no record of strong long-term performance, and evidence of style drift, you'd do well to bypass this fund and look elsewhere.
Actionable advice
As you can see, it takes a little bit of research to separate the grain from the chaff and determine whether a fund is worth your money. But it's much better to make a wise, informed decision than a hasty one that could tie up your assets in the wrong kind of fund.
Luckily, we're here to help. I'll give you a chance to look at all the research we've done for the Champion Funds newsletter service, complete with every fund that meets our tough screening process, entirely free for the next 30 days with no obligation to subscribe. Click here for more details.
Fool analyst Adam J. Wiederman owns no shares in any of the companies above. The Fool's disclosure policy is the best investment out there.
