Comparisons to Other Mutual Funds Can Be Misleading

Marketing gimmicks in the financial services industry are rampant. Many investors are realizing that they cannot trust wall street as evidenced by the outflow of fund from actively managed funds and inflow to passively managed funds.The main street solution is to own equities, gloablly diversify and rebalance.

Mutual Fund Playas
Mutual Fund Playas (Photo credit: greggoconnell)

Since 100 percent of its retirement funds beat their 5-year Lipper average, investors could believe that T. Rowe Price has found a way to consistently “beat the market”. Is this accurate?Not if you understand how the use of benchmarks can be misleading.

Lipper mutual fund averages are benchmarks that measure the performance of funds in a given category against other funds in that category. The fact that all of the retirement funds managed by T. Rowe Price beat their Lipper averages means they were better than the average performance of the other funds measured by Lipper. While interesting, it tells you nothing about how those funds performed against their benchmark indexes.

Morningstar assigns a benchmark index to each mutual fund it rates. This is the index against which the performance of a given fund can be measured. These indexes are assigned by the Morningstar fund analyst team, based on its Morningstar category. It is the index the Morningstar analyst team believes is the most appropriate benchmark for the Morningstar category.

The performance of a fund against its appropriate index is a more accurate way to evaluate the performance of a mutual fund. Think of it this way. If the average 8th grader can run a 100 yard dash in 20 seconds and your child took 40 seconds, you might be concerned. However, if the only information you had was that your child was better than the average in his class (and the average in his class was 45 seconds), you might believe he was in great shape.

Using data from Morningstar (for example see here), Index Funds Advisors calculated the returns for the five-year period ending December 31, 2011 of the T. Rowe Price Retirement funds against their analyst assigned benchmark. This was the same period used by T. Rowe Price to measure performance against the Lipper average. We measured the performance of all 33 T. Rowe Price Retirement Funds. The results were surprising. None of them equaled (much less beat) their Morningstar analyst assigned benchmark. Underperformance ranged from 0.84 percent to 1.73 percent (annualized). Only twelve of these funds are available for direct purchase by individual investors.

The marketing machine of the major mutual fund families are continuously looking for ways to peddle their funds. Most of these methods are misleading to investors. Armies of lawyers for these funds make sure the wording of the marketing pieces will get their firm into court.

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