100 / 772
2
but not most muni funds. The upshot was that muni-
fund investors have sold just before a strong rally
twice in the past five years.
Drilling Down to Categories
One type of fund stands out as a great match of
investor and fund: target-date funds. Across the
board, target-date funds have positive return gaps,
meaning that investors are making the most out
of those funds. The fact that the funds are almost
exclusively held in
401
(k)s is the most important
element. Clearly, the discipline of investing more from
every paycheck works wonders. When you see funds
with the worst return gaps, they are usually highly
volatile ones that inspire attempts at market-timing.
The evidence shows we do far better when we ignore
the headlines and stick to our plans.
That brings me to some of the biggest return gaps:
regional stock funds. The four worst are India, diversi-
fied Pacific/Asia, Europe, and Japan. These are all
fine places to invest, but they inspire people to make
bold macroeconomic calls that tend to go poorly. It’s
worth remembering that the link between economic
growth and markets is surprisingly tenuous. Also,
buying after good economic news will often lead you
to overpriced securities just as buying after a good
earnings report will.
A Bright Line on Risk
What happens if you separate funds based on Morn-
ingstar Risk? It turns out the impact is dramatic.
The lowest-risk quartile has a
6
.
56% 10
-year annual-
ized return versus a
5
.
3%
average return, making for
a positive return gap of
126
basis points. The second-
lowest-risk quartile dipped to a still respectable
5
.
88%
return and a gap of
4
basis points. The third-
lowest-risk quartile had a
5
.
63%
average investor
return, making for a
32
basis point gap. Finally, the
highest-risk quartile of funds had an average invest-
or return of
4
.
53%
—that’s more than
200
basis points
worse than the lowest-risk quartile—and it had a
gap of
132
basis points.
The Impact of Fees
I spliced investor returns by expense-ratio quartile
and found some interesting results. Not only did
investing in the cheapest quartile deliver better
investor returns, but it also led to a smaller gap. So
that means investors in cheap funds chose higher-
returning funds and used them better than those in
higher-cost funds.
For example, the
10
-year U.S. equity return for the
average investor was
6
.
92%
, with a gap of
119
basis
points. However, investors in the priciest quartile
had a meager
3
.
71%
return on average and a huge
gap of
299
basis points.
Overall, the average investor return across all funds
was
5
.
61%
for the cheapest quintile and
3
.
28%
for
the priciest. The gap was
80
basis points for the
cheapest quintile and
179
basis points for the priciest.
Funds With High Investor Returns
Which funds had the highest investor returns in abso-
lute terms? It was largely those with highest total
returns.
T. Rowe Price Health Sciences
PRHSX
,
Fidelity Select Health Care
FSPHX
,
T. Rowe Price
Media & Telecommunications
PRMTX
,
T. Rowe
Price Global Technology
PRGTX
, and
Primecap
Odyssey Aggressive Growth
POAGX
led the way.
But perhaps more informative is the list of those with
top-percentile investor returns for their category.
In all, nine Morningstar
500
funds landed in the top
percentile of their peers, and most had less volati-
lity than their peers. Also noteworthy was the consis-
tency of their returns. These nine tended to consis-
Mind the Gap 2015: Better Results for Investors
Continued From Cover
Asset-Weighted and Average Total and Investor Returns—Trailing Through 12/31/2014
U.S. Equity
Sector
Equity
Allocation
Intl Equity
Taxable
Bond
Municipal
Bond
All Funds
p
Average 10-Yr Total Return (%)
p
Asset-Weighted 10-Yr Investor Return (%)
p
Returns Gap (%)
7.47
6.49
-0.98
0.02
-0.02
-1.19
-0.69
-1.30
7.16
7.18
5.42
5.40
4.44
3.75
3.66
2.36
5.75
5.21
-0.54
12
9
6
3
0
5.74
4.55