By Chuck Jaffe, MarketWatch
BOSTON (MarketWatch) -- If you were handed an authoritative list of the "best" mutual funds for the next year, it would be hard to believe that any would turn out poorly if you picked them.
And yet, if you chose the funds that Morningstar Mutual Funds has tapped as the best for the year ahead, you'd be making the Stupid Investment of the Week.
There's no denying that the names on Morningstar's /zigman2/quotes/209325896/composite MORN -2.11% list include some stellar funds -- nine of the 12 get four- or five-star ratings from the investment researcher -- and there's no reason to believe any of the funds will send you to the poor house. But the logic behind the list and the way it will be viewed and used by some consumers makes these funds more dangerous than they might otherwise seem.
Morningstar's "best funds for 2010" are Dodge & Cox Income /zigman2/quotes/205671106/realtime DODIX +0.14% , Fidelity Government Income /zigman2/quotes/208727413/realtime FGOVX +0.38% , Longleaf Partners /zigman2/quotes/202270593/realtime LLPFX -2.19% , Schwab Total Stock Market Index /zigman2/quotes/205824660/realtime SWTSX -1.95% , Manning & Napier Worldwide Opportunities , Mutual Quest /zigman2/quotes/208873719/realtime TEQIX -0.75% , T. Rowe Price Spectrum Income /zigman2/quotes/209256313/realtime RPSIX 0.00% , Royce Premier /zigman2/quotes/202170996/realtime RYPRX -1.25% , Artisan International Value /zigman2/quotes/207322356/realtime ARTKX -1.24% , Vanguard Inflation-Protected Securities /zigman2/quotes/207983017/realtime VIPSX +0.50% , Vanguard Convertible Securities , and Wasatch Small Cap Growth /zigman2/quotes/203015609/realtime WAAEX -2.24% .
Without naming specific funds, the newsletter also singled out the target-date funds of Vanguard and T. Rowe Price for investors who want a life-cycle issue.
Financial advice for an uncertain 2010
Dick Bellmer, president of Deerfield Financial Advisors, talks with WSJ's Daisy Maxey about what his company is recommending to its clients for 2010.
Stupid Investment of the Week highlights the concerns and conditions that make securities less than ideal for the average investor, and is written in the hope that spotlighting trouble in one case will make danger easier to avoid elsewhere. While obviously not a purchase recommendation, this column also is not an automatic sell signal, particularly in the case of these funds, where the concern is more about buying off the list -- picking a fund because it's the "best" of anything.
Morningstar Mutual Funds started listing the best funds for the year ahead six years ago. Typically, most funds that have made the list are "analyst picks" at the firm -- meaning the favorites of Morningstar's analytical crew -- with established managers and investment styles.
The list itself seems to run contrary to Morningstar's own institutional thinking. The firm has always been focused on the long haul, with virtually every analyst I have ever talked to far more concerned with what a fund will do over the next five years than the next 12 months.
From the start, the editors of the newsletter have hedged their bets a bit, suggesting the selections were for the next year "and beyond." This year, Karen Anderson, taking her first shot at the list as editor of Morningstar Mutual Funds, makes no bones about the idea that "whether you're constructing your portfolio for the first time or looking to make some upgrades, I've compiled a list of offerings that investors should consider for the long haul."
But when you say you are producing a list of "the best funds" for the coming year, you create an expectation that the issues you pick will actually be good performers in the year ahead. There, Morningstar hasn't done so well.
Over the first five years of this endeavor, 71 funds were named to the list (in about one-seventh of those picks, a fund actually made the list for a second or third year). Using year-to-date data for 2009, nearly two-thirds of the funds picked landed in the top half of their peer group during the year for which they were expected to be "best."
But beating the category average isn't what you expect from "best" funds; a better hurdle would be finishing in the top 25% of the asset class, and just 22 of 71 picks (31%) did that.
"Morningstar has a lot of smart people who are trying their best, and who are smart statisticians," said Mark Hulbert of the Hulbert Financial Digest, which ranks the performance of investment newsletters and is a service of MarketWatch, the publisher of this report.
"What they are revealing with these lists," he added, "is just how difficult it is for any of us to identify top performers, to say 'This is what's going to be the next great investment.' Even among funds with absolutely fabulous track records, picking next year's winners is tough."
If you consider that every Morningstar editor creating this annual list has suggested that the funds they picked would be good long-term performers, then the one calendar year that now has a five-year history -- the picks for 2005 -- should have all been long-term winners. That didn't happen. While 20% of the picks from that year rank in the top 10% of their peer group, roughly half of the "best funds for 2005" fall below their category average over the last half decade.
It's not just the performance that is the problem with this list. If you tried to use it to build a portfolio, there would be significant overlap. Each year's list is published without reflection on the previous year, or any mention of what someone might do if they bought those other funds. Moving from one annual list to the next would generate tremendous turnover.
Anderson acknowledged that investors shouldn't use the list as the bedrock of a portfolio. In fact, she suggested that investors shouldn't necessarily be jumping ship in similar funds to buy these issues, even if they don't have something that is considered the best for 2010.
"As long as the same things are in place today as when you bought the fund -- the analyst's opinion is the same, your confidence is the same and you are satisfied with the fund -- I don't think you sell one fund just to buy something that is on the list," she said. "But the list can be a good starting point. And if you aren't happy with your fund in a specific category, you might find something better here. ... It's just not a ready-made portfolio."
Instead, the "best funds for 2010" is more like a gimmick -- fun to read and to chat about, but not in keeping with the long-term thinking that investors (and Morningstar analysts) typically use.
Said Dan Wiener, editor of the Independent Advisor for Vanguard Investors: "This is good marketing for Morningstar. What it's not is good investing."