Why your fund manager can't wait for New Year's

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The revelers in Times Square won't be the only ones eagerly counting down the seconds until midnight this coming New Year's Eve. They'll be joined by many stock fund managers, who will be enthusiastically waving goodbye to 2011. The reason for their cheer has nothing to do with the performance of the stock market in 2011 (although that's certainly reason enough) and everything to do with the fact that moving into 2012 means that 2008 rolls off their funds' three-year returns.

Returns over the trailing one, three, five and 10 years are the standard currency of the mutual-fund industry -- the time periods that are most typically used to asses each fund's performance. And 2008, as you doubtless recall, was a particularly brutal year for stock investors, as the financial crisis spurred a 37 percent drop in the S&P 500.

As you might imagine, a year like that can really destroy a three-year record. How much so? Consider that for the three year period of 2008 through 2010, the average stock fund earned an average annual return of -1.5 percent. If we move that period up 11 months -- eliminating most of 2008 and adding most of 2011 -- that average annual return vaults to 16.3 percent.

Obviously the calendar's turn doesn't mean that 2008 never happened. It still affects the funds' five- and 10-year returns and is certainly available to any investor who wishes to see how a particular fund fared during the global financial crisis.

But while that's true, mutual fund managers know that the huge percentage-point swing they'll be getting on their three year returns is priceless in an industry in which performance and cash flow are inextricably bound. So you can understand their giddiness at the prospect of sweeping a horrible year a little farther under the rug.

But that doesn't mean investors should let 2008 slip into the recesses of their minds because those are precisely the sort of markets that active managers are being paid to help their clients navigate. So the next time you find yourself captivated by a fund with compelling three-year record, dig a little deeper to make sure you see how it fared when given a true chance to test its mettle.

  • Nathan Hale

    View all articles by Nathan Hale on CBS MoneyWatch »
    Nathan Hale has spent decades working in the financial services industry, during which he has researched and written extensively about personal investing, the mutual fund industry, and financial services. In this role, he uses a nom de plume because many of his opinions about the mutual fund industry and its practices would not endear him to its participants.

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