Less Active Traders Outshine Frequent Buyers, Study Shows

Investors are taught to think long-term when it comes to buying stocks: Put money into your mutual funds regularly and hold on. Too bad the professional stock-pickers who oversee the investments aren’t that patient.

The average mutual fund manager holds a stock for about 12 months; that is, he turns over his whole list of stocks virtually once a year, according to the Chicago-based research group Morningstar Inc. And there’s increasing evidence that these active traders aren’t doing their shareholders any favors.

Fast-turnover funds generated an average return for investors of 22.8% in the three years ended May 31, Morningstar found. In contrast, stock funds that only changed 20% of their investments each year--or took five years to turn over their entire holdings--had an average gain of 25.8% in the same period.

Low-turnover funds also did better in the past 10 years, rising an average of 16.2% while high-turnover funds gained an average of 15.6%, Morningstar reported.


“Most managers add little to returns by puttering with their portfolios,” said Susan Dziubinski, a Morningstar analyst.

Frequent trading increases a fund’s costs and hurts returns over time, Dziubinski said. Furthermore, by selling in a hurry, fund managers often miss out on the full appreciation of their holdings, she said.

Heavy trading may have its place at funds that invest in small companies. This is the more volatile part of the market, Dziubinski said, and skillful trading can enhance returns despite the higher commissions the funds pay.

Still, the statistics suggest that for most funds, the ones that invest in larger companies, the best strategy is “make good stock picks and then hold on,” Dziubinski said.


Investors can easily determine a fund’s portfolio turnover by looking at a fund’s annual report, said Tim Medley, an investment advisor in Jackson, Miss.

“I’ve never liked the gin-rummy approach to fund management--take one card, throw away another,” Medley said. “I like managers who hold stocks for four or five years, as opposed to those who have a 12- to 18-month time horizon.”

Medley recommended three low-turnover funds that he thinks are good investments. They are Oakmark Fund, Clipper Fund and Selected American Shares.

To that list, Dziubinski adds slow-to-trade such as Waddell & Reed Growth Fund, the White Oak Growth Stock Fund, the Papp America-Abroad Fund, the Babson Value Fund and the Wachovia Growth & Income Fund.

One of the worst performers in the high-turnover category is American Heritage Fund. The fund’s average stock is sold after being held for 2 1/2 months, and in the past five years, American Heritage has lost an average of 6.44% annually for its investors, according to Bloomberg Fund Performance.

“We do have a high turnover, but 85% of the holdings in the fund have been there for an average of 6 1/2 years,” said Heiko Thieme, the fund’s manager. “I don’t touch our core holdings, Senetek and ADM Tronics.”

Frequent trading hurts fund investors in yet another way. High-turnover funds--at least those that make money--usually generate large capital gains each year. Shareholders who don’t hold the funds in tax-deferred accounts have to pay taxes on those gains, further eating into their real gains.

Add higher taxes and lagging returns together, and it would seem investors would be wise to put their money with fund managers who have the same buy-and-hold mentality the investors themselves are supposed to have.


Tim Quinson writes about mutual funds for Bloomberg News.


The Portfolio Two-Step

A Morningstar study showed that fund managers generally do better for their funds by leaving portfolios alone. However, a minority of managers have regularly added value with their trading. Below are the mutual funds whose managers’ trading activity most consistently added value since 1993.

Fund: Waddell & Reed (800) 366-5465 Added % Return per year: 8.76%

Reduced volatility per year: -0.26

5-year annualized % return: 23.57%

5-year % rank category: 9%


Category: MG

Turnover: 37%

No. of holdings: 55

Assets, in millions: $334

Morningstar Comments: Mark Seferovich buys rapidly growing firms in Growth B cutting-edge industries, holds lots of cash. (Fund open to new investors.)


Fund: Janus Mercury* (800) 525-8983

Added % return per year: 5.93

Reduced volatility per year: -0.19

5-year annualized % return: 24.56

5-year % rank category: 6

Category: MG

Turnover: 157

No. of holdings: 74

Assests, in millions: 2,200

Morningstar Comments: Warren Lammert likes reasonably priced earnings growth, regardless of market cap size. (Fund open to new investors.)


Fund: Longleaf Partners Small Cap** (800) 445-9469

Added % return per year: 3.29

Reduced volatility per year: -0.37

5-year annualized % return: 21.77

5-year % rank category: 14

Catefory: SV

Turnover: 17

No. of holdings: 36

Assests, in millions: 1,200

Morningstar comments: Mason Hawkins and Staley Cates pick stocks TRading at 60% or less of their intrinsic values. (Fund closed to new investors.)


Fund: Growth Fund of Washington (800) 972-9274

Added % return per year: 3.06

Reduced volatility per year: -0.42

5-year annualized % return: 19.78

5-year % rank category: 33

Category: MV

Turnover: 13

No. of holdings: 8

Assests, in millions: 70.8

Morningstar comments: Prabha Carpenter buys undervalued stocks of any size with ties to the Washington, D.C., area. Fund open to new investors.)


Fund: White Oak Growth (888) 462-5386

Added % return per year: 2.54

Reduced volatility per year: -0.79

5-year annualized % return: 29.12

5-year % rank category: 2

Category: LG

Turnover: 8

No. of holdings: 24

Assests, in millions: 637

Morningstar comments: Jim Oelschlager wants sectors that should out-perform and companies with strong earnings growth. (Fund open to new investors.)


Fund: Fidelity Stock Selector (800) 544-8888

Added % return per year: 2.15

Reduced volatility per year: -2.12

5-year annualized % return: 21.42

5-year % rank category: 35

Category: LB

Turnover: 117

No. of holdings: 251

Assests, in millions: 2,000

Morningstar comments: Brad Lewis’ quantitative model looks for short-term trends and picks stocks to exploit them. (Fund open to new investors.)


Fund: Papp America-Abroad (800) 421-4004

Added % return per year: 2.07

Reduced volatility per year: -0.15

5-year annualized % return: 24.99

5-year % rank category: 7

Category: LG

Turnover: 5

No. of holdings: 29

Assests, in millions: 369

Morningstar comments: Roy and Rosellen Papp buy big U.S. stocks to play globalization and technological development. (Fund open to new investors.)


Fund: Babson Value (800) 422-2766

Added % return per year: 1.94

Reduced volatility per year: -0.58

5-year annualized % return: 23.75

5-year % rank category: 5

Category: LV

Turnover: 17

No. of holdings: 47

Assests, in millions: 1,700

Nick Whitridge uses quantitative and qualitative factors to find cheap, growing stocks. (Fund open to new investors.)


Fund: Loomis Sayles Core Value Instl (800) 633-3330

Added % return per year: 1.72

Reduced volatility per year: -0.04

5-year annualized % return: 20.55

5-year % rank category: 22

Category: MB

Turnover: 64

No. of holdings: 64

Assests, in millions: 73

Morningstar comments: Jeffrey Wardlow focuses on low price-to-earnings and low price-to-sales companies with solid management. (Fund open to new investors.)


Fund: Fidelity New Millennium (800) 544-8888

Added % return per year: 1.66

Reduced volatility per year: -0.13

5-year annualized % return: 26.14

5-year % rank category: 3

Category: MG

Turnover: 142

No. of holdings: 335

Assests, in millions: 1,700

Morningstar comments: Neal Miller identifies top-down themes and picks companies to capitalize on them. (Fund closed to new investors.)


Fund: Oak Value (800) 622-2474

Added % return per year: 1.13

Reduced volatility per year: -0.74

5-year annualized % return: 26.07

5-year % rank category: 4

Category: MG

Turnover: 22

No. of holdings: 24

Assests, in millions: 327

Morningstar comments: David Carr and George Brumley demand good cash flows and management at moderate prices. (Fund open to new investors.)


Fund: HomeState PA Growth (800) 232-0224

Added % return per year: 1.13

Reduced volatility per year: -3.25

5-year annualized % return: 24.38

5-year % rank category: 2

Category: SB

Turnover: 50

No. of holdings: 118

Assests, in millions: 133

Morningstar comments: Ken Mertz targets market leaders from Pennsylvania with earnings growth of 20% or more. (Fund open to new investors.)


Fund: Wachovia Growth & Income (800) 994-4414

Added % return per year: 1.08

Reduced volatility per year: -0.11

5-year annualized % return: 20.71

5-year % rank category: 42

Category: LB

Turnover: 12

No. of holdings: 71

Assests, in millions: 345

Morningstar comments: Paul Baran favors steady growers with international businesses and solid returns on equity. (Fund open to new investors.)


Data through April 30.

*Since this study was completed, Janus Mercury moved to the large-growth category.

**The managers also run Longleaf Partners, a medium blend fund that, with a 2.33% added return, also qualified for this list.

Morningstar’s methodology: The study’s findings are based on risk-adjusted returns. To determine the returns of a fund’s static portfolio, Morningstar calculated how much its first reported portfolio for each calendar year since 1993 would have returned over the next 12 months. To calculate volatility, a 12-month standard deviation was calculated from those return figures using the 90-day Treasury bill and the Lehman Bros. aggregate bond index as proxies for cash and bond positions. Only portfolios in which pricing data were available for at least 75% of the holdings were screened. Morningstar then compared the returns and standard deviations of both the static and actual portfolios for the same periods. To come up with an aggregate value-added return figure for a fund, the differences in return for each year were summed and averaged, as were the standard deviation figures.