Mutual Funds That Beat S&P 500 Index

In the third part of the 2007 Consumer Reports Ultimate Money Guide, a method was provided by the magazine on how to beat the broad market index, which is repeated in the following:

  • No-load: Look at no-load funds only.
  • Low-fee: Identify those with lowest expense ratios.
  • High-asset: Keep those with the most assets under management.
  • Long-tenure: Get rid of funds whose manager’ tenure is less then two years.

Though it’s commonly believed that in the long term, a majority of the actively managed mutual funds, with the promise of providing investors with better return, failed to deliver, there are still some funds that outperform the S&P 500 index in extended period of time. The above method is actually a general guideline in selecting a mutual fund, not just those that beat the S&P, and I usually use 3 out of the 4 steps when researching mutual funds. However, I never applied them all in selecting a fund.

With beating the S&P 500 index in my mind, last night I used Morningstar’s mutual fund screening tool to see if I can find any winner with the method suggested by Consumer Reports. Here are my criteria:

  • Fund group: Domestic Stock
  • Morningstar category: Large Value
  • Manager tenure greater than or equal to: 5 Years
  • Minimum initial purchase less than or equal to: $3,000
  • Load funds: No-Load funds only
  • Expense ratio less than or equal to: 1.00%
  • Morningstar Star Rating: None
  • Morningstar risk better than or equal to: Average
  • 5 year return greater than or equal to: S&P 500
  • 10-year return greater than or equal to: S&P 500
  • Turnover less than or equal to: Category Average
  • Total assets less than or equal to: $5bil.

So basically, I was looking for low-cost funds, low risk funds that beat the S&P index in 5- and 10-year period that also require a reasonable minimum initial investment. Given these criteria, the Moningstar fund selector returned only four funds:

mutual funds that beat s&P

Details of these funds are shown in the following table. Among these funds, ING Corporate Leaders Trust B (LEXCX) has the lowest expense ratio (ER) and the highest long-term return, beating the S&P 500 index by almost 4 percentage points in the past decade. The fund’s total assets is $467 mil., which is quite small compared to other larger-cap funds.

Fund ER (%) YTD return (%) 3-yr return (%) 5-yr return (%) 10-yr return (%)
HMVMV 0.94 3.44 10.97 14.18 6.74
HOVLX 0.71 5.13 12.08 14.36 8.01
LEXCX 0.49 9.98 13.98 16.35 8.40
YACKX 0.96 2.79 6.80 11.50 8.24
S&P 500 N/A 4.70 7.63 10.37 4.48

Then I kept all other criteria the same, but changed the Morningstar category from Large Value to Large Growth. Another six funds returned, which are listed in the table below.

Fund ER (%) YTD return (%) 3-yr return (%) 5-yr return (%) 10-yr return (%)
SMMIX 0.91 17.12 12.81 15.23 5.40
FMIRX 1.00 3.59 10.27 13.96 6.58
FKDNX 0.97 22.28 10.69 13.92 7.63
FKCGX 0.96 17.76 10.23 15.33 9.02
FKGRX 0.91 10.09 11.34 13.70 6.77
ITGIX 0.74 10.35 10.72 13.11 7.68
S&P 500 N/A 4.70 7.63 10.37 4.48

Of course, all these funds are selected based on their returns in the past. Though we all know that past performance doesn’t guarantee future returns, history is all we have right now and it’s an important gauge to make our selections. Can these funds maintain their performances and beat the index in the next 5, 10 years? Nobody knows, but if I would choose a fund for my long-term investment, I definitely won’t pick a fund with terrible historical returns and hope for the best for the future. I will still check out the fund’s history and pick a winner, though maybe not the winner as listed in the above tables :)

How do you select your funds?

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7 Responses to “Mutual Funds That Beat S&P 500 Index”

  1. junger |  Dec 07, 2007 at 12:38 pm

    I take the much easier route … investing in Vanguard’s S&P 500 index fund.

  2. Mickey Blue Eyes |  Dec 07, 2007 at 1:47 pm

    One criteria that should be included is length of tenure of the fund manager. If the 5 and 10 year performance is due to another fund manager, then it may not get the same performance going forward. I would posit that manager tenure is at least as important as Morningstar category and asset size.

  3. MossySF |  Dec 08, 2007 at 9:18 pm

    Picking funds with terrible recent history isn’t that far off. Reversion to mean is a common occurence — today’s losers often become tomorrow’s winners and vice versa. Now the problem is deciding whether today’s losers are down because their style is out of favor, they’re unlucky or they’re just crappy managers. It’s impossible to tell until after the fact so for this type of scheme, I’d stick with broad indexes and pick the sectors/classes/sizes/tyles that have done the worse. For example, this year REIT and Small Cap Value are down and probably will continue to go down for some time until the housing/mortgage fallout is over. So I’d begin a multi-year DCA into REIT/SCV using money from sectors that have been booming lately (e.g. International, EM, TIPS).

  4. Richard |  Dec 10, 2007 at 6:36 pm

    There’s a downside to funds with lots of assets – if you’re counting on the manager to pick undervalued stocks they’ll only have a limited number of opportunities, and more assets means they have to either hold lots of cash or choose weaker stocks, bringing down the average returns.

    To the person who recommends looking for funds with bad performance: past successes don’t mean there will be future successes, but past failures are an even worse indicator – especially with the recent gains. What you want are funds managed by people who have had past successes, but are well-priced now.

    A good example of a successful fund is given in the book Unconventional Success: the fund in question has a 10-year record of beating the S&P 500 by 4% with the same managers, but has slow years; in particular, the book mentions a lot of investors leaving it when it underperformed the internet bubble (earning a poor Morningstar rating). It’s also closed to new investments on and off, since there’s only so companies that meet the managers’ criteria. In addition, the managers and many employees of the management company (as well as their families) invest in the fund – so good performance is more than a way to gain assets and fees. It has reduced the expense ratio in the past. You’ve thought of some of these requirements, but if it’s possible to add more factors to the morningstart search it might help refine the list.

    In the mutual fund world it can be hard to figure out who’s really trying to give investors bigger returns without additional risk and who’s just trying to track an index and collect fees for “picking the right stocks”. I hadn’t thought of using a method like this to find the few truly superior funds, but it’s an interesting idea.

    If you do find a good fund, it might have slow years when a regular index is doing well, so balancing it with other assets could still help.

  5. irina |  Dec 11, 2007 at 5:37 pm

    I recently read “Rational Investing in Irrational Times” by Larry E. Swedroe and his other books. In his outspoken books, Mr. Swedroe virtually destroys mutual funds credibility in favor of index funds.
    Another interesting book I am reading is by Patrick W. Rice “IRA Wealth, Revolutionary IRA Strategies for Real Estate Investment.”
    At this point I am not sure what I am going to do with my IRA funds which are invested in mutual funds!
    If anyone wants to review those two books, it would be great.

  6. Anon |  Dec 18, 2007 at 12:34 pm

    There is an easy way to test this theory. Go back 5 years, and find the funds that outperformed for the preceeding 10 years. Then see if they still outperform today.

  7. Andy |  Dec 21, 2007 at 1:52 pm

    I select based on expense ratio, duration and experience or management team, what they are invested in (international focus works best for now) and past performance compared to peers. Vanguard normally works best for me.