Of the 408 mutual funds reviewed, the majority of them no longer had five stars. This and another study by S&P Dow Jones Indices underscore the common fallacy that investing in a five-star mutual fund increases the likelihood of a positive long-term outcome.1
Determining which funds to invest in should go well beyond a five-star rating system. In fact, you need a financial advisor who is dedicated to your needs and specializes in independent and ongoing assessment of investment options. High net worth investors should consider separately managed accounts instead of mutual funds given potential tax and visibility benefits.
Morningstar’s study found that funds that were once leaders of their investment categories had dropped out of favor. 37% lost one star 10 years later, 31% lost two, 14% lost three and 3% lost four stars. This illustrates the importance of monitoring investments over time.
A separate study conducted by S&P Dow Jones Indices found similar results, discovering that over the last four years (through March 2014) only two of 715 top-performing US stock mutual funds managed to remain in the top 25%.1
Some mutual funds aren’t good at adapting their strategies to growth, according to Morningstar’s Director of Fund Research, Russel Kinnel. As new investors pour assets into a high-performing fund, the fund managers often struggle to find effective ways of investing the cash while also maintaining the integrity and effectiveness of the strategy.
For example, the Thornburg International Value Fund, which went from managing $2.1 billion at the end of 2004 to $18 billion by the end of 2007—but also saw its Morningstar rating fall from five stars to two.1
Since a mutual fund is only as good as its portfolio managers, it’s important to make sure there aren’t major changes to the management team while you’re invested. You will want to be aware if the team responsible for the five-star rating leaves the fund. A management team shakeup could put future performance at risk.
At WrapManager, we believe having a Separately Managed Account (SMA) can help you to avoid some of the bigger pitfalls associated with mutual fund investing.
SMA’s can provide you the following:
If a mutual fund incurs capital gains in a given year, it must distribute the taxable gains to individual shareholders—even if you didn’t sell any shares of the fund that year!2 With an SMA, you may be able to request that the money manager attempt to limit gains or losses based on your tax situation. Often you can also make custom requests to realize any end-of-year losses to offset gains.
An SMA can provide you with a more transparent picture of what you’re invested in, and you can monitor trades closely within your portfolio. With a mutual fund you often own so many stocks, bonds and other assets that you’re not fully aware of what’s really in your portfolio nor what’s being bought or sold and when.
Don’t want any tobacco stocks in your portfolio? With an SMA you can discuss your specific investment objectives with your financial advisor and they may be able make adjustments to the SMA based on your specific needs. With mutual funds, you can’t control what stocks or bonds you own within the fund.
Knowing that SMAs have certain advantages over mutual funds is only the first half—you also need to know which money managers to hire. Working with a financial advisor who spends time and resources independently evaluating money managers can give you the information you need and save you time.
Your financial advisor should recommend money managers that address your objectives and fit into your investment plan. You should also be invested in various money manager strategies that focus on specific areas of investing, like international and tactical money managers.
The next, and perhaps most important step, is making sure your selected money managers continue to perform well and continue to make sense for you. If there’s a shakeup with the management team, if the performance outlook is bleak, or if the money manager shifts the strategy in such a way that it no longer meets your needs, then there’s a good chance it’s time to move on.
Your financial advisor should continually monitor all of these factors and proactively reach out to you if a change is needed.
To discover what money managers we're currently recommending for our clients based on their objectives, contact one of our Wealth Managers at 1-800-541-7774 or Wealth@WrapManager.com. We can analyze your goals for retirement and evaluate your current holdings, while giving you information on the money manager strategies we think could make sense for you and your retirement plan.
Gabriel is the President of WrapManager, Inc. and Chairman of WrapManger's Investment Policy Committee.
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2 Investment News
To the extent this presentation includes any state or federal tax advice, the presentation is not intended or written by WrapManager, Inc. to be used, and cannot be used, for the purpose of avoiding federal tax penalties. WrapManager, Inc. does not advise on any income tax requirements or issues. Use of any information presented by WrapManager, Inc. is for general information only and does not represent tax advice either express or implied. You are encouraged to seek professional tax advice for income tax questions and assistance.