Katie Rushkewicz Reichart, CFA, is a senior analyst covering equity strategies on Morningstar’s manager research team.
Unfortunately, you haven't had to go to an amusement park to feel queasy lately, as the market has delivered a wild ride of its own over the past two years. Many investors suffered steeper losses during 2008's meltdown than they ever could have imagined. Clearly there was no way to predict the magnitude of the market decline, and there were few places to hide. But some funds staved off losses better than others, a fact that isn't all that surprising when considering how they've behaved during past downturns. No two bear markets are alike, of course, but understanding a fund's volatility before buying it can help investors keep their expectations in check. Understanding the losses a fund may incur can also help you limit it to a small position in your portfolio--or avoid it altogether.Why Volatility Matters
Investors don't always make the best decisions. They often buy funds when they're hot and sell when they tank, causing them to lose more money in the long run. (See my colleague David Kathman's article
for more information about investor returns.) This phenomenon is especially noticeable with volatile funds because investors buy them when they're on the leader's list and often can't hang on to them during down periods.
It's nearly impossible to predict the market's movements, but investors can feel better about their portfolios by picking funds that fit their risk tolerances. That can be tough, because investors often don't realize how risk-averse they are until a blowup hits. However simply understanding their funds--and how volatile they're apt to be--is a worthwhile first step.A New Perspective
The new Chart feature on Morningstar.com gives investors an easy and intuitive way to see how a fund's returns have varied over time. Simply pull up a fund and click on the Chart tab in the navigation bar at the top of a fund's page. In contrast with our Total Returns tab, which shows you a fund's return versus its category peers and a market benchmark over preset trailing periods, the Chart tool lets you create your own view of performance. The tool defaults to a Growth of $10,000 graph, but I like to change it to rolling returns. (Hover over the Growth tab to find that option.) The rolling three-month period is a good start, but changing it to a longer time frame (up to 60 months) is useful if the fund's manager has a long track record. Simply hover over "3 months" and click on any of the preset time periods.
A rolling return lets you evaluate a fund's performance outside the confines of a calendar year or trailing period. Rather than looking at the number of calendar years in which a fund has had losses, you can instead look at the number of 12-month periods in which a fund has posted losses: from March 2005 to March 2006, then April 2005 to April 2006, and so on. Observing more time periods gives you a better view of how a fund has behaved in the past, and that's why our analysts use rolling returns a lot when evaluating funds. Rolling returns also give you an idea of how volatile a fund has been over time and whether there will be a lot of ups and downs.
For an example of our new charts in action, look at Analyst Pick Turner Midcap Growth Investor
. This fund's painful 49% loss in 2008 was worse than 80% of its mid-growth rivals. While the absolute loss was unprecedented, its relative performance isn't all that surprising. If you look at its rolling return graph, you'll see the fund has lagged its peers (represented by the orange line) in nearly all down markets.
For a close-up view, click to the interactive graph
, then select Rolling Returns from the Growth dropdown menu. Hover over a specific part of the graph and a blue dot will appear. Then look above the chart to see exactly how much the fund underperformed the average mid-growth fund and the S&P 500 during that period. However, the fund has had much bigger gains when the market turns around, leading to a 7.7% annualized return since its 1996 inception--twice the category average. Investors shouldn't buy it, though, unless they can handle its bumpy nature.
Analyst Pick Allianz NFJ Small Cap Value
is the opposite case. Looking at its rolling return graph, you'll see it's lost less money than its peers during downturns--it beat 90% of its rivals in 2008 and also did well in the bear market in the early 2000s--but tends to lag during market rallies due to its strict valuation focus. Ultimately, its stellar long-term record is what matters the most, but its ability to protect capital in tough times makes it especially appealing for cautious investors.Custom Time Periods
In addition to rolling returns, our new chart tool lets you look at a fund's returns over specific time periods. A fund's trailing three-, five-, and 10-year total returns can be of limited use if there's been a manager or strategy change during that timeframe. The chart tool works around this problem by letting you customize the time period to coordinate with the manager's tenure or a market environment, like the bear market from 2000-03. Simply type in the beginning and end dates in the boxes at the top left-hand side.
Consider Harbor International Growth
, a fund that has had a series of manager changes. Its trailing 10-year record is awful, but current manager Jim Gendelman, who took over in 2004, is not responsible for most of it. If you change the date on the rolling return chart to March 1, 2004 (Gendelman's start date), you'll see the fund has been quite competitive since he came on board. In fact, the fund's 3% annualized gain during his tenure beats 65% of its peers.
You can also customize the peer groups that are used in the chart. Hover over the Benchmark menu to choose from a variety of indexes or categories. You can enter tickers of other funds as well; this can be helpful if you're trying to decide between two funds.