American Funds and the Limits of 10-year Return Figures

How does an investor go about picking a good mutual fund to buy for the long haul - one that will leave you with more money than a passively-managed fund? Though we've heard countless times the caveats about "past performance," it's one of the first things most people look at when sizing up a fund. A recent look at Growth Fund of America (GFA) shows how even long-term performance figures can be poor indicators of how a mutual fund has performed for investors who invested money along the way.

First, a bit about the fund, which focuses on Large-cap Growth stocks. It's one of dozens available from American Funds, a fund family that has been around for decades, and that became especially popular in the mid-2000s. The funds are actively managed, meaning a fund like GFA picks stocks and tries to do better than you'd do with a comparable index fund. Among the American Funds offerings, GFA is a very old fund (since 1973), and it's enormous! Or was, anyway, with over $200 billion invested in it back in 2007. Drops in the value of investments and cash-outs by investors ($33 billion in 2011 alone) have shrunk the fund since then. But it's still one of the larger US stock funds in existence - over $120 billion in assets as I write this.

Investors wishing to purchase American Funds mutual funds in their IRA or taxable investment account access the funds through commission-based brokers. GFA has several available share classes for such retail accounts, but Class A shares are (and have been) the most commonly purchased - they're about half of the assets held by GFA, most recently. Class A shares have a 5.75% front-end sales load, which means that for $1,000 invested, $942.50 actually buys shares of the fund and the rest goes to commissions. That load can be reduced or waived entirely if you purchase or own enough American Funds products, or if you hold the fund in certain account types. Point being, both the "load" and "load-waived" returns can be relevant, even for Class A shares whose rack-rate front-end load is 5.75%.

An investor in the mid 2000s looking at GFA would have seen a history of good returns over many years. And assessing the fund now, the fund's long-haul return would still appear solid. Look: (image is from a table in the fund's most recent semi-annual report)

snippet from American Funds GFA semi-annual report 2-28-2013

Though the 5-year figures lagged, and 1-year was almost a dead heat, the fund looked to be ahead of the S&P 500 - which is often used as a Large-cap Growth benchmark index - over the past 10 years, and well ahead of it over the fund's lifetime. Those lifetime results date back to December 1, 1973. You might conclude that this is a fund that has rewarded those who stuck with it.

But here's the problem...what if you weren't even born yet in 1973? What if you didn't have any money invested 10 years ago, but did so on some random day since then - or you added money along the way? Do those long-term return figures still point to a winning fund?

It takes some number-crunching but it's possible to run a bunch of historical "horse races" between a mutual fund like GFA and a comparable passively-managed mutual fund such as an S&P 500 index fund. Not just for the published, end-0f-month or quarterly figures, but for every single possible day that you might have put money into the fund. To me that's more interesting than looking at "since inception" returns, which happened when much less money was invested in the fund (how many "since-inception" investors are still living and still in the fund?). And as of July 31, 2013, that comparison told a somewhat different story than the last 10-year or lifetime figures. Look:

 

AGTHX vs VFINX thru 7-31-2013

 

First, you can see that the 10-year numbers (shares purchased during 2003 and held continuously until today) look solid. But look at the years since then. That's a lot of red rectangles, isn't it? Each red sliver represents a day that someone buying Class A shares of Growth Fund of America ended up with less money than someone buying shares of Vanguard's 500 index fund on that same day. That's been the case for many of the purchase dates over the past 5-6 years, ignoring any loads. And if there was a 5.75% front-end load, the fund has underperformed the Vanguard index fund for most years over the past decade. Not just on the random quarterly reporting periods, but on every single possible day that you could have purchased the fund since mid-2005.  Think of that! That certainly isn't clear from looking at the periodic return figures, or the typical "mountain chart"< illustrating the growth of an investment over time.

I see a few take-aways here:

  • Understand the limits of 10-year return figures - they're valid for telling you about money that was invested exactly ten years ago, through the end of the reporting period. Those figures tell you little about what's happened for money invested since then. The same principle applies for any reporting period (3-year, 5-year, lifetime). Just seeing how a fund has performed in the past is more difficult than it seems.
  • A 5.75% sales load can turn a winning fund into an underperformer. AGTHX has "won" relative to the S&P 500 index fund at numerous times over the past few years, but only if that 5.75% sales load didn't apply. Costs matter.
  • An(other) example of active vs. passive. GFA is an actively-managed fund, and one of the largest in the world with over $200 billion in assets at its peak. To me the returns of the latter part of the past decade are an example of how difficult it is to manage a large pot of money and still come out ahead of your benchmark index. Winners become less likely to repeat their winning performance, if only because of asset size. This is one factor in what I call the "Mutual Fund Selection Problem," that is much less of an issue with passively-managed funds.

Some might argue that GFA can put up to 25% of its money in non-US stocks, and can hold cash univested - it's done a bit of both. In contrast, VFINX blindly tracks the S&P 500, an index of Large US companies. Foreign stocks have done poorly recently, which hurt returns of mutual funds like GFA that owned them, and cash sat still during the stock market rise of early 2013. So - the argument goes - the S&P 500 isn't a fair comparison index and GFA's numbers look better if compared to something that factors in a non-US stock benchmark.

I'm not sure I buy that argument. GFA is marketed as a Large Growth fund, which makes the Large-Growth-heavy S&P 500 a valid benchmark. The overseas and cash holdings in GFA aren't mandatory, and presumably the management team at American Funds will only invest overseas or go to cash if they think there's an advantage to doing so. The red areas in the comparison charts suggest these active-management decisions didn't pay off for many shareholders.

Finally, I mentioned that GFA is sold largely through commission-based brokers, with standard Class A loads being 5.75%. The commission may have paid not only for access to the fund, but also for some kind of advice. Buying Vanguard 500 at no load comes with no advice - or if it does, there's probably some additional cost to factor into the comparison (like my management fee, for example). To avoid this issue, look at the comparison chart without loads factored in. And of course, if the only advice tied to a front-end load on GFA was to buy that fund instead of some boring index fund, the return comparison suggests it might not have been particularly valuable advice for many investors.

Please don't interpret this piece as specific investment advice, or a recommendation to buy or sell GFA. The charts are simply meant to illustrate a recent example where 10-year return figures vary significantly from those over shorter periods, for a widely-held mutual fund that is actively managed.