When it comes to catastrophes and disasters, anniversaries typically bring up bad memories.
With mutual funds, key anniversaries erase them.
Thus, as investors marked the five-year anniversary of the collapse of Lehman Brothers — the signature event of the financial crisis of 2008 — mutual fund companies are watching as the passage of time removes all of that pain from five-year performance records. While the financial crisis actually sucked 50 percent of the value out of the Dow Jones industrial average over an 18-month period from October 2007 through early March 2009, funds took the worst of it in the two months after the Sept. 15, 2008, collapse of Lehman.
Removing that experience from the five-year look back creates a before/after picture that’s as startling as the sudden transformation of a 98-pound weakling into a pumped-up, sculpted contender for Mr. Universe.
For example, the average large-cap growth fund entered September with a five-year annualized return of 6.38 percent, according to Morningstar Inc. If the market simply stays flat and the average fund stands still to the end of the year, that five-year average will be 9.2 percent once September is wiped off the books, and will reach 15.16 percent by the end of the year.
Put another way, expecting a 0.0 percent return for the rest of the year is akin to simply shrinking the track record by four months, removing the first of the 60 months in the time frame.
When you take the fall of 2008 off the books, according to Lipper Inc., the cumulative return of the average large-cap core fund would go from 37.82 percent entering September to 94.14 percent by the end of the year. The typical financial-services sector fund, which now reports a total gain of 27.5 percent since August 2008, will see its five-year results shoot to roughly 106.5 percent by year’s end, simply by holding steady through December.
Because the financial crisis spared no sector or category from its misery, virtually every category is slated to see massive improvement by year’s end, barring another market catastrophe.
The two questions this sudden change brings are whether investors recognize that the performance-enhancing drug in five-year records was time, being used as a painkiller to get the worst of the crisis out of the five-year lens, and what fund companies will do with those suddenly sexy half-decade numbers.
“Equity funds are still bleeding assets from the 2008 crisis, so one would have to think fund sponsors will jump on the improvement in the five-year records and turn up the heat in saying how well they have done since the market stressed funds back then,” said Geoff Bobroff, an industry consultant based in East Greenwich, R.I. “They may push it more in the materials going to (advisers and brokers) than directly to the individual investor, but they have something to sell now, and some companies definitely will sell it.”
Industry observers have long pointed to studies showing how past performance is, at best, a flawed predictor of future results. The inherent ability to cherry-pick time frames to deliver good-looking results is a big reason why.
At the start of 2010, for example, the financial crisis was front-and-center in short-term track records, and trying to ease the pain by looking back 10 years wasn’t much help, because the decade included the bear market that occurred when the Internet bubble burst in 2000.
Now the 2008 catastrophe is about to be out of five-year records, and the 10-year performance results have dropped the bear market of 2000-2003.
“Funds, basically, are market-timing their records,” said David Trainer, president of New Constructs Inc., the Nashville-based research firm. “They’ll use their five-year record — or whatever record they think looks good to investors – when it suits them, and sweep it under the rug when it doesn’t. … Now they will say their five-year performance is good; we’ll see if people believe them and act on it.”
What may be standing in the way is investors’ pain reflex.
This is less about risk tolerance than about the memory of past injuries. Investors internalize losses, and the 50 percent drop of the financial crisis isn’t leaving their heads, even if it is leaving five-year histories; the pain feels as if it was just yesterday, which is why so many investors have had a tough time getting all the way back into the equity market even as it rode a new bull market to record highs.
Investors have reason to be skeptical, noted Trainer. If the average large-cap value fund is going to see its five-year annualized performance jump from 6.2 percent entering this month to 13.4 percent at the end of December (again, assuming 0.0 percent movement in the fund between now and year’s end), it’s only a mirage that makes it look like performance is twice as good. “That change in what the five-year numbers look like is so big so fast, but it’s not like the funds actually got better overnight,” he said.
That’s why it’s important that investors not only note the anniversary of the financial crisis, but remember it. Having seen funds at their worst, investors can factor future market meltdowns into their planning. Forgetting that pain – or ignoring it based on recent positives – is a good way to ensure that they will feel it again, the next time there’s a market crisis.Chuck Jaffe is senior columnist for MarketWatch. He can be reached at firstname.lastname@example.org or at PO Box 70, Cohasset, MA 02025-0070.