lack of transparency, tax inefficiency, and overall lackluster performance.
I recently read an article from The Street questioning whether a retiree should even consider owning a mutual fund anymore. It cracked me up when they asked Matthew Tuttle (who runs an ETF) his thoughts on the matter and he responded with: “It is simple — ETFs blow mutual funds away”.
Shocking response huh? That’s like asking Tim Cook if he thinks Apple Inc. (AAPL) makes the best mobile phone.
In general, I’m a firm believer that the low-cost, transparency, liquidity, tax efficiency, and innovative nature of ETFs make them a far superior product to most mutual funds. My first preference when building out client portfolios is to find a suitable ETF for a given asset class or strategy. Nevertheless, like most things in this world, there are always exceptions to the rule.
The primary reason someone should purchase a mutual fund versus an ETF is the implementation of a unique strategy (with superior performance history) for which there is no suitable ETF candidate available.
I’ll admit that these opportunities are few and far between in the world of stocks. Most actively managed stock funds are simply closet index products with higher fees. Many studies have disproved the value in stock picking versus simply owning a passively managed benchmark over long periods of time. There just isn’t much alpha to be had despite the marketing claims that superior research and security selection will lead to greater returns.
Instead of trying to beat the S&P 500 with a mutual fund, just go out and purchasethe SPDR S&P 500 ETF (SPY) or Vanguard Total Stock Market ETF (VTI). With these ETFs, you know exactly what you own and how it will perform versus its peers.
Now in the world of fixed-income, there are still some very solid choices for investors that want to counteract volatility or seek excess returns above the benchmark. The Doubleline Total Return Fund (DBLTX), PIMCO Income Fund(PIMIX), and Loomis Sayles Bond Fund (LSBDX) are three examples of actively managed bond funds with superior track records.
A comparison of these funds over a 5-year time period versus a standard benchmark such as the iShares Core U.S. Aggregate Bond ETF (AGG) shows a tremendous advantage in all three strategies. We aren’t talking about basis points here. We are talking about returns that are more than double the most widely used fixed-income benchmark.
All of these mutual funds have expense ratios that are markedly higher than a comparable ETF. However, they have proven to be far superior in their overall returns and their managers have shown dominant skill in risk management as well. Expertise in managing the underlying holdings to hone in on specific duration or credit exposure will also be key to successfully navigating the next noteworthy interest rate cycle.
For the moment, there are no ETF alternatives to the three funds that I mentioned above, although both Doubleline and PIMCO have introduced ETFs in other categories. I would certainly leap at the chance to lower internal expenses and enhance daily liquidity in the event that ETFs based on these strategies ever materialize in the future.
The Bottom Line
There are still a limited number of mutual funds that can add value in your portfolio through unique investment strategies. Keep in mind that expenses are an important factor in this equation, but should not exclude a mutual fund with a proven track record of success from your options.
In my opinion, retirees that rely heavily on income from their portfolio are well served with a hybrid mix of low-cost ETFs and well-researched mutual funds. The balance between these two worlds can unlock superior performance and create a balanced asset allocation framework.
Other Important Notes
While these are just a small sample of top actively managed mutual funds, there are a variety of others in the income arena that have proven their worth as well. Free services such as Morningstar and others can help you filter and analyze differing options based on their rankings. Remember that before purchasing a mutual fund, make sure that you thoroughly research its fee structure to ensure you choose the lowest cost offering available.
This article is brought to you courtesy of David Fabian from FMD Capital Management.