Top-Ranked MFS Looking to Keep Active Mutual Funds Alive
It’s not easy to find an actively managed fund that does what it is supposed to, which is to provide above average and not below average returns. MFS is doing its best.
It is actually pretty amazing how so many poor performing mutual funds there are out there, and how people continue to invest in them and stay in them in spite of their earning less money with them than they should.
A lot of investors are happy enough to just shoot for what we call market returns by investing in baskets of stocks like the S&P 500. While we call this market returns, even major indexes just offer us slices of the overall market, for instance with the 500 large cap companies that populate this popular index. We’ve chosen this as the benchmark though, and since we could just buy this index instead of something else, it’s natural that funds would be seeking to beat it to provide some sort of reason why people should invest with them.
We would think though that investors would see a fund being consistently beat by the S&P 500, and especially by the better performing Nasdaq, and turn away from it. The goal with investing is supposed to be to shoot for better returns if you can, and that’s the goal with actively managed mutual funds as well, so if they don’t deliver, why do people just keep coming back?
There could only be one possible reason for this, and that’s the fact that a lot of investors simply invest blindly, perhaps being handed a fund over the table by an advisor or seeing an ad and jumping on a fund without any further thought.
This is no way to invest of course, and while there are investors who will compare active funds to decide which one to invest in, a lot don’t make much of a comparison with the actual benchmark, the return we could have had by investing in the S&P 500 or other major stock index.
In order to make sense of investing in an active fund, there must be a reasonable expectation that it will provide something better, otherwise we’re choosing a worse option on purpose. Returns versus the benchmark is something that should be very transparent, but the funds themselves won’t be that eager to show their warts and this does take a tiny bit of research on our part to flesh this all out, and it seems that a tiny bit is beyond the threshold of interest of a lot of investors.
There is no substitute for looking at charts here, something that takes us even further from the amount if participation that many investors which to engage in, but even looking at something like a 5-year return should tell the story well enough, and if your prospective fund isn’t cutting it, it has lost the fight and at least needs to show us one day that it can win this battle before we sink our money into it.
When we have a peek at how the charts compare though, we can gain some additional insight as to how our fund moves relative to the market, and account for both risk and return considerations. Both are important, and even though investors misunderstand risk by trying to view it independently of return, we can see how both risk and return fit together by seeking how an asset has moved over time.
We might even want say that given that 4 out of 5 active funds fail, we should just toss the lot, as a random selection would lose. There’s also the fact that the 1 out of 4 that beat the market last year will not be the same 1 in 4 that will do it this year, so the success rate over time will be less than 20%.
At a minimum though, any funds we pick are going to have to at least have a higher probability of beating the market than not, and this will require that they show us that they can do this over a decent length of time. We don’t want to have our lookback period too short, like just looking at last year where a fund may have gotten lucky, or too long, like 15 years where a lot may have changed since, and something in the middle like 7 years is nether too short or too long and will give us a good idea of where a fund stands relative to other investment options.
It’s not that a lot of investors haven’t woken up to this challenge of comparing their returns to the market, and once they have seen that the market is beating their funds, they have been moving more and more toward passively managed mutual funds and ETFs. We still have about half of all the money in funds still placed in active funds, so there is much more opportunity for investors to come to this realization as it is appropriate to do so.
Many people will still strive to uncover funds that may actually be worthy, and we don’t want to just give up here, but whatever funds we do find will have to at least be able to compete with the S&P 500, if not the Nasdaq. For this article at least, we’ll use the S&P 500 as the benchmark, even though the risk/return of the Nasdaq is superior. If you can’t beat the weaker of these two indexes though, you are failing more unequivocally. We’ll still take a peek at the Nasdaq though if one of these funds actually beats the S&P, where they still need to beat the champion to declare full victory.
The main problem with actively managed funds is that the fund managers screw up their picks so much, and when we see their picks underperform the market even without management costs factored in, there is no other possibility. Most tend to be afraid of momentum to some degree, and this has them preferring below average performing assets over better performing ones, which is a sure way to lose to your average stock.
If not for this, it would be a lot easier to put together a fund that would succeed in its mission, and it’s not that some funds don’t try to do this more. Those are the ones that do better, what we call growth funds, where you pick stocks that are expected to grow more and avoid those with lesser potential.
Since the idea is to grow the value of our portfolios, and stocks that grow more will grow our portfolios more, and stocks that grow less will grow it less, we should not have to even think about what sort of stocks we want to be holding, the ones that simply do better. So many investors and even fund managers don’t even make it this far in their deliberation though.
Taking a Look at the Top-Rated Fund Company’s Top 3 Funds
If you’re looking for a place to start looking for better than your standard fare of losing, it makes sense to at least have a look at the top ranked mutual fund company, which is currently MFS. They may not be a household name like some of their bigger competitors, but they have been offering mutual funds for almost 100 years now, and have over $300 billion in assets under management.
MFS is currently rated as the number one fund company by Lipper, and although that may pique our interest enough to have a look, we cannot ever allow ourselves to be sold on any fund this easily, and we’re going to need to look into their top funds a little deeper than this.
MFS offers a total of 95 funds, which shows just how segmented this market is, but only one is ahead of the market over the last 12 months, which is not surprisingly, their large cap growth fund, the MFS Growth Fund.
We’ll also look at their two other funds that are also considered to be the top 3 funds that they offer, the MFS Value Fund and the MFS Total Return Bond Fund. In terms of popularity, their value fund leads the way with $58 billion of assets, with their growth fund having $28 billion in it right now, and their bond fund managing $7 billion in assets.
We actually want to start with the biggest, the value fund, and the fact that this has twice as much money invested in it than their growth fund tells an interesting story in itself. The mission with their growth fund is simply to pick good stocks, while with their value fund, they seek to pick stocks which aren’t quite as good but ones that the fund managers expect will do better next year.
This is a nice idea, although if you seek to do that, it does matter whether or not you are successful at it, and failing at this task year after year, and overall, just doesn’t cut it unless your goal actually is to shoot for lower returns. We continue to be mystified by how many people sign up for the potential for better returns and don’t even seem to notice when this idea fails year after year.
The MFS Value Fund actually had a pretty good year in 2019, gaining 24%, and although that’s not quite as much as the S&P 500 gained last year, they at least get to brag that they beat the Russell 1000 Value Index, not that this is anything to brag about as this still leaves open the question of why people wouldn’t want to go with the S&P 500 instead or why anyone would ever want to invest in this lesser index.
Funds are going to always want to put their best face forward, even though this may mean putting a smile on an ugly one. MFS chief investment officer Ted Malones shares their philosophy with this fund: “Companies that have more durable, less volatile earnings and cash flow are the types of companies we tend to be attracted to—and those were the companies that the market rewarded in 2019.”
He didn’t mention the fact that his companies were rewarded less than your average stock in 2019 though, as if this does not matter. If you don’t take your eye off of your own fund and look around a bit, and we wouldn’t think that comparing it with the benchmark that funds use to measure their progress would take much thought, then perhaps you can dupe yourself into thinking that you are doing well.
We don’t just want to look at a single year to measure a fund’s progress though, and last year’s returns were brought up quite a bit by having their biggest holding, JPMorgan Chase, gain 43%, after it got beat up way more than it deserved the year before and then had this corrected.
We need to see how picking companies based upon his criteria does over a little more time than this, and we can start with comparing the fund’s two- year return to the market. The S&P 500 is up 24% over this time, while the MFS Value Fund has only gone up by 11%. That’s not exactly beating the market.
Let’s go back 5 years to get an even better perspective. The MFS Value Fund has moved up by 29% over this time, while the S&P 500 advanced by 60%. If we stretch this out to 7 years, this has the S&P 500 gaining 125% while the MFS Value Fund only managed 67%. This isn’t just getting beaten by the market, it is being clobbered by it.
If you are happy getting only half the returns of the market over time, this fund may be perfect for you, although you do need to deduct the 5.75% front-end load from all returns, where you can buy the big index without a load and even without commissions at all these days by buying an ETF. They might think they are selecting for better performance, and they may be telling us they are doing that, but the facts tell an entirely different story and expose their delusion in its full nakedness.
Let’s move on next to their bond fund, and while we may think that this is certainly a fund that we need to segment, comparing it to bond fund indexes. If we have to go with a bond fund, this might make sense, but whether or not we do or whether or not it makes sense to in a given situation can be another story entirely.
As we often mention, investing in bond funds when stocks are bullish is simply a crazy idea period, regardless of your circumstances. We don’t even have to go into the performance of this bond fund because they all pale so much compared to stocks, even their value fund, although we should at least throw out the numbers here to at least provide some perspective.
This fund has moved up by 7% over the last 2 years, 2% over the last 5, and 1% over the last 7. Anyone who thinks that this fund has provided some nice returns over this time just isn’t using their head at all. This one not only needs to be buried but encased in cement. Whatever this has beaten should not interest us and far from it.
To rub salt on this gaping wound, this requires that we pay a 4.25% load fee, and given how much higher this is proportionately to the returns of their value fund, this is simply an investment horror show.
What We End Up with in the End Is What We Need to Look At
While we do collect redemptions from these funds, with the bonds representing interest collected and stock funds paying dividends, and bond funds tending to yield a little more than stock funds do, we don’t want to allow this tiny difference to take our eye off the fact that this little gain is offset by many times when we look at how much we failed to gain with the value of our shares in a fund. Even a whole percentage difference in yields over the last 7 years only adds up to 7%, and the gap with the S&P 500 over this time was 124% (the 125% that the S&P rose compared to the 1% this fund did overall), so being behind overall by 118% should not be making us smile or feeling smug.
While investors may claim that they need to be in bonds to hedge the drawdown risk with a bear market with stocks, these things never happen in the blink of an eye, and those who were around for the 2008 crash will remember this as a process over time where we knew the market was in trouble all the way. Those who chose to hang on to their stocks were well aware of the risks, and the time to decide this while it is happening, when the air raid sirens are sounding, not hiding in your fallout shelter just in case.
As it turns out with these things, even if we had one of these 50% crashes once every 7 years that happened in the blink of an eye, and it happened at the exact time you had to cash in all your money, going with the Nasdaq over the last 7 years instead of bonds would still leave you up 150% or a 21% better return each of these 7 years even after the haircut. People invest in bonds during bull markets because the fear they feel has suspended their thinking to the point that they are too afraid to start thinking a little about what they are doing.
That’s way more often than these crashes happen in real life, where there has only been 3 of these in the 49-year history of the Nasdaq, the market takes months to unravel, we never have to cash out completely at the bottom, and we never need to take the full loss even if we hang on because we can hold for the recovery.
The most important thing to realize though is that as the years go by, these last 7 years for instance, and you rack up an advantage of 40% per year, by the time this happens, if it does, we’re still way ahead even after the crash, to the point where just one year worth of extra returns will almost cover it and 2 years’ worth will leave us set and already racking up more and more gravy. Why live in a cardboard box on purpose when you can get a room at a good hotel?
With their first 2 funds on the rocks, we can now look at their growth fund, the one where they are at least giving themselves a fighting chance to beat the market. Given that the goal here is actually to beat the market, picking better stocks on average, this shouldn’t be that hard to do, although their 5.75% load fee is going to make this more challenging.
Aside from having to part with 5.75% of our money just to get in on a fund like this, load fees also make our investments more illiquid, as you can’t just move in and out of them without paying a huge price. What this means is that these funds can’t really be timed the way we may need them to, as for instance if you wanted to step aside during a correction, what you may save from doing this is going to require that you deduct 5.75% from this amount just to get even.
While we should just say no to load funds, and to mutual funds entirely actually, as ETFs are simply superior, we still want to see how this fund fared and if we can at least get some insight into how MFS earned its top rating among fund companies. It the threshold includes our needing to make sense of investing in a fund, these first two are well beneath that threshold, and if their growth fund doesn’t deliver, there really wouldn’t be a single fund that deserves our interest because this is their top performer.
This time though, we will deduct the load from our returns over the various periods, and while we should be comparing its returns with a growth fund index, we’ll start with the S&P 500 as this will at least allow them to brag that they beat that index, the absolute minimum threshold to make sense of a growth fund.
This growth fund has returned 34% over the last 2 years, bettering the S&P 500 by 10%, although that advantage gets cut in half when we calculate the load fee in. Still though, this leaves us with a 5% advantage over two years, nothing to sneeze at and in line with the fund’s objectives of beating the market.
Over the last 5, the MFS Growth Fund has risen by 86%, which even after we deduct the 5.75% load fee in, still provides an advantage of 20% over the S&P 500, or 4% net additional return per year. This passes our test nicely as well.
Finally, over the last 7 years, this fund has beaten the S&P 500 by 30%, which has us netting 24% more, or about 3.5% per year. That’s clearly beating the market as well, this one at least.
This means that we can confidently say that this fund beats the S&P 500 over time, even after the load fees, and this is what a growth fund is supposed to do. They are making up for the additional fees and then some, where we’re left considerably better off on a net basis.
We can’t just look away from the Nasdaq’s performance though, an index that is more populated with growth stocks than the S&P 500 is, and if this fund cannot beat the Nasdaq, they might be able to brag that they beat the S&P 500 but still don’t have a reasonable claim to our money.
On a net basis, less load fees, the Nasdaq has beaten this fund by 19% over the last 5 years, and by a whopping 154% over the last 7, seeing the Nasdaq up 304% over this time with the MFS Growth Fund only advancing by 150% net of their load fee. Even without taking this out, 304% is simply a lot bigger number than 155%.
When your best performing fund has lagged a major index by an average of 22% over the last 7 years, this turns out to be nothing worthy of bragging about. In the end, there is no other reasonable conclusion than to our needing to look away from MFS’s funds entirely, number one rated or not. If this is the best that the mutual funds industry can offer us with active funds, the only thing we are left to wonder about is why these funds aren’t dying a lot faster than they are.
These folks think that they can pick better stocks, but unless they actually do, they are failing at their jobs. When you fall below average, when you fall this hard against an index that requires no skill or decision making whatsoever, over a considerable amount of time, you need to recognize that you simply lack the skills to succeed and you do not deserve to ask anyone to join you in your quest and need to rely on investor confusion.
As long as they continue to shine their flashlights directly into the eyes of investors though, it might be a long time before enough investors look at the value of these funds honestly enough to perceive their lacks. Anything that is supposed to be beating the indexes but instead gets knocked unconscious by them requires us to be unconscious as well to want to stick with them. We are starting to come to our senses more about this lately, although this is a slow process indeed. With investing, even the worst ideas die very hard.
Chief Editor, MarketReview.com
Ken has a way of making even the most complex of ideas in finance simple enough to understand by all and looks to take every topic to a higher level.
Contact Ken: ken@marketreview.com
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