By law, mutual funds must disclose its performance for the past 1, 3 and 5 years. However, one wonders whether the 5 year, much less the 3 year number, is a relevant analytical tool. A recent survey of institutional fund managers found that the average hold period for a stock was 17 months with almost a fifth of all fund managers holding a particular stock for less than a year. There are various reasons for such high turnover; one particular reason is that Standard & Poors found that the average life of a mutual fund manager is 5.6 years.
In other words, the 5 year return may have been accomplished by a different manager with a substantially different portfolio. Thus, unless the manager has had a long tenure managing the mutual fund and turnover is quite low, the potential investor may not be comparing apples to apples and, as Rob Carrick points out, high turnover costs the mutual fund investor money.
The solution seems to be taken right out of the sports pages. Mutual funds/sport teams perform best with long-standing managers/coaches who can execute a long-term strategy with substantially the same core of stocks/players. One only has to look at the performance of the Toronto sports teams as of late to show the adverse impact of quick management turnover and knee-jerk trades. In the investing sphere, Morningstar has found that mutual funds with the highest turnover of stocks underperformed the slowest trading funds by 1.8% over the past decade. Movement for movement’s sake produces neither a good sports team or portfolios.
The morale of the story, whether for mutual fund or passive investors, is to stick to a reasonable strategy for long periods of time and not be so quick to change management.
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