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Using Performance Data to Help Choose

November 24, 1996|CLINT WILLIS | Clint Willis is a freelance writer who covers mutual funds for Reuters

Many mutual fund investors trying to choose among the thousands of mutual funds available start by comparing performance records.

After all, if a fund has delivered solid returns over the last, say, five years, then it probably can continue to do well in the future.

Or can it?

Many investors discover that an outstanding long-term record doesn't always translate into superior returns in the future. That can happen for any number of reasons.

For example, the manager who generated those returns may leave the fund, turning over the reins to a less experienced or less talented successor.

The fund's investment style may no longer work, causing the fund to slip into a prolonged slump. The manager may simply run out of luck, with a series of bad picks that create unpleasant surprises for shareholders. He or she may change his investment strategy or make a large bet that doesn't pay off.

It's the way they always say in the advertisements: Past performance is no guarantee of future results.

That said, past performance can help you choose mutual funds for your portfolio. But you must use the information properly, taking into account the factors that shape that performance.

When you are judging a fund's past returns, keep several points in mind. For one thing, how did similar funds perform? It's not fair to compare the performance of an aggressive growth fund with the gains recorded by a bond fund.

Likewise, you wouldn't compare the record of a growth-and-income fund that aims for capital growth and current income with that of a growth fund that primarily pursues long-term growth. Each category of funds pursues different goals, and that results in different performances over short and long periods.

Thus, if you are looking for a growth-and-income fund, compare its returns with those of other growth-and-income funds. You can find out the average returns of a fund category in Morningstar Mutual Funds, available at many libraries, or in publications such as The Times' quarterly reports. Then compare those figures with the performance of the fund you are considering as an investment.

For example, balanced funds delivered 10.5% annual returns during the past three years, and 11% annually during the past five years. That compares with 10.3% and 14.3%, respectively, for the Lindner Dividend Fund ([314] 727-5305; $2,000 minimum investment; recent yield: 6.3%).

Sounds interesting--but don't buy yet. Does the record reflect a consistent philosophy? Some funds generate solid returns by chasing fads--they buy whatever is hot this year and then switch to the next hot sector next year. When that strategy works, it can deliver strong gains. But what if your manager jumps on the wrong trend, or the current hot sector collapses before he or she gets out?

Ideally, you should invest in funds that choose a consistent investment approach.

For example, Morningstar notes that Lindner Dividend Fund manager Eric Ryback buys securities that meet strict value criteria and pay above-average dividends, focusing on individual security selection rather than on plays in trendy sectors.

If you research magazine or newspaper articles, you would find that Ryback has maintained a consistent investment philosophy through a variety of market conditions.

What risks did the fund incur? A call to the fund company could turn up information about how it has performed in different market conditions.

In this case, it turns out that the Lindner Dividend Fund has been 41% less volatile than the average balanced fund during the last three years, and 64% less volatile during the last five years.

The upshot: Lindner Dividend not only has a strong performance record in its category and is driven by a consistent investment philosophy, it also has kept risk well in hand. Those factors are still no guarantee that the fund will do well in the future--but they are about as close as you're going to get to such assurance.

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