People use a lot of different methods for telling the future, from numbers to mirrors to random dots made on paper, tarot cards, reading the smoke from an altar, dropping hot wax onto water and more.
Most aren’t particularly reliable.
In nearly 20 years of covering the mutual fund business, I’d like to think my annual forecasts for what will happen in the industry in the year ahead have been significantly more accurate. I have typically gotten about three-fourths of my prognostications right — and the ones I miss on, typically, are more about being “early” than flat-out wrong — which I suspect is more reliable than most star-gazing methods.
If that’s the case, then there’s a good chance that at least five of the following items will become stories that dominate the mutual fund world in the year ahead.
The big fund stories for 2014 will include:
1. Misleading five-year track records becoming the dominant sales pitch.
The worst of the financial crisis of 2008 is already gone from five-year track records; the rest will be gone by the end of March.
Nobody is going to be pushing 15-year returns — about 4.5 percent annualized on the Standard & Poor’s 500, including bear markets starting in 2000 and ’08 — or 10-year gains (roughly 7.25 percent on the S&P) when they can hype double-digit gains such as the 17 percent annualized the index has delivered over the last five years.
At a time when investors are feeling optimistic — hoping that the strong results from 2013 can somehow continue unabated — this is the number investment firms will focus on, because they know that pushing recent short-term numbers as if they can happen again is irresponsible. The five-year time frame is a bit reckless right now, too, but that’s not going to bother the fund world.
2. Unpleasant tax surprises from some big 2013 winners.
With all of the tax-loss carry-forwards from 2008 exhausted, funds are again building up large positions that will generate taxable distributions.
No one minds these payouts in a year like 2013, when funds were way up and the taxes feel like a cost of doing business.
Market forecasts suggest that returns will be in low- to mid-single digits. If that happens, funds could lock in gains and generate tax bills that equal or eclipse their growth in 2014; when that happens — mediocre returns with oversized tax bills — it creates unhappy investors.
3. Big-name invaders into the ETF space.
I made this call a year ago and it did not happen, largely because of the ineffectiveness of the U.S. Securities and Exchange Commission. That logjam should break this year.
One oddity in the evolution of exchange-traded funds is that Vanguard effectively has been the only fund firm allowed to create an ETF share class for its traditional funds (Vanguard actually has a patent on the process, which expires in 2019). The competition has approached the SEC about allowing a “hub-and-spoke system,” where ETF versions of traditional mutual funds could be created as an extension of the existing issue.
It’s different from what Vanguard does mostly in semantics, but if the SEC finally gives in, Fidelity, T. Rowe Price and others appear ready to jump into the ETF space hard.
Within 12 months of SEC approval, the ETF landscape will look a lot more like the traditional fund world in terms of being able to spot the big players.
4. No bond-fund meltdown.
Market watchers have been warning for years now that the moment rates started to creep up, bond funds would crater. That didn’t happen late in 2013, when long-term Treasuries ticked up but funds suffered through years that were flat or had moderate declines.
With the Federal Reserve determined to keep short-term rates ultra-low for the foreseeable future, the slight interest-rate increases that do come into play won’t create a massive problem in bond funds, where rising rates typically send share prices cratering.
Flat or down slightly again? Sure. Crushing losses in bond funds? Not this year.
5. Alternative funds failing to do their biggest job.
The worst label in mutual funds is the one that says something is “alternative,” because these types of funds have become so mainstream. That said, alternative funds are supposed to hold something besides stocks, bonds and cash, providing an alternative to traditional investments.
Most of them don’t get too far afield, however; so when market returns are muted this year, investors will be disappointed to find out that the funds they picked to diversify their portfolio — and to ride a different wave — are so closely correlated to the market that they don’t see much benefit to the alternative lifestyle.
6. International funds providing bigger returns than domestic funds.
When looking at 2013 in review, it’s hard to ignore that the domestic market was up about 33 percent, or about 10 points better than most international markets. It’s easy to forget that the international markets led the domestics over the last half of the year.
Expect that trend to continue, even as investors throw the bulk of their dollars into domestic issues.
7. A run of goofy, gimmicky investment concepts tested in new funds, mostly ETFs.
The fund world has a long history of trotting out silly concepts, and the ETF space is the hot place to do that now. So expect a raft of “event-driven,” “data-dependent” or “specialty” funds, ideas curious enough to make headlines but not sufficiently interesting to draw much in assets, or steeped enough in theory to deliver superior returns.
The mutual fund graveyard is full of these kind of flops; the Hall of Fame has few if any of these gimmicky issues.Chuck Jaffe is senior columnist for MarketWatch. He can be reached at cjaffe@MarketWatch.com or at P.O. Box 70, Cohasset, MA 02025-0070.