Mutual Fund Performance - A Case Study

As a professional investor, I’ve read quite a few annual reports. If you include quarterly reports, they number well over ten thousand. Early in my career this activity was limited to reports from companies, but now I research mutual funds of all types too. One section you see in every fund report is a discussion about past performance. While “past performance is no guarantee of future results” as the boilerplate legal language says, it can give you clues as to how a fund invests. Past performance should also raise certain questions in every portfolio manager’s mind. Namely, why do we own (or want to own) this fund?

Reading through the report of one highly regarded real estate fund, I was struck by how the manager portrayed their performance. Because I do actually respect this shop and their process, we are going to leave the fund nameless. Let me present the performance data now, before discussion, so as not to taint your first opinion of it. I urge you to study the table and draw your own conclusion before continuing.

Clearly, the fund has underperformed in the last year and in the 3-year period, which is not alarming in and of itself. But the fund has also underperformed in the 5 and 10-year periods as well. Ok, well what does management have to say about this? I quote:

“As indicated above, the Fund’s long-term track record compares favorably” to the benchmark.

It does? All I see is that they had decent performance in the first 3.5 years of the fund’s existence and they highlight the statistical fact that since inception the numbers are good. Not so good if you missed those years but held on for the last decade though. But perhaps there is more to the story?

Indeed there is. Combing through annual performance data instead of rolling year periods, we find that this fund actually outperformed handily for the first 9 full years of its existence, beating the benchmark in 7 of those 9 years. In fact, they beat the benchmark in 8 of 12 or two-thirds of the full calendar years available, which is normally an impressive feat. The table, in this SEC required format, is highly misleading in terms of the accomplishments of this fund. Despite the good intentions of standardized performance reporting (which I still applaud), it certainly does not present an accurate picture in all cases. One lesson here is that investors who don’t look deeper will often miss the larger picture. But there remains more to this story, which we’ll examine in a not-too-distant future post.

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