Investors in more than two dozen U.S. and Canadian equity mutual funds and exchange-traded funds (ETFs) experienced the good fortune of seeing increases of more than 100 per cent in 2020. Now, they’re asking, will the good times last or is it time to sell?
That was the question Jeffrey Ptak, chief ratings officer at Morningstar Inc. in Chicago, asked as he saw that 18 U.S. equity funds had triple-digit gains last year – the most since 2009. Nine Canadian equity funds also rose by that same margin in 2020.
The title of his report, What to Expect From Funds After They Gain 100 per cent or More in a Year? Trouble, Mostly, provides a hint.
“[The report] was trying to place that small cohort of funds ... in a larger historical context so people could set expectations in a better way,” he says. “I thought that was important in these cases because when you set your eyes on these types of gains, immediately … some investors get excited, and they start salivating and they want a piece of that action.”
There’s no wonder why investors would take a close look at these funds as the 18 U.S. funds racked up an average gain of 127 per cent last year. The nine Canadian funds rose by an average of 150 per cent in 2020, says Ian Tam, director of investment research with Morningstar Canada, who pulled the data on Canadian funds.
“It’s great if you have a triple-digit gainer in your portfolio,” Mr. Ptak says. “But what you want to do is understand why you have a fund that scored a huge gain in such a short period of time.”
That doesn’t always mean it’s time to sell, he notes.
“The answer to that question could be perfectly acceptable,” Mr. Ptak says. “It could be that the same fund experienced a big loss in the period of time that preceded its big gain, and if you view its performance over that full arc, it doesn’t look that much out of the ordinary.”
But many of the funds on the list had a big gain in 2020 on top of a big gain in 2019, and “in a situation like that, you want to burrow in” and examine why the fund’s value skyrocketed, he says.
Some funds with big gains invested in a specific area that has seen huge growth, as we’ve seen in technology in recent years, so the rise makes sense, Mr. Ptak adds.
Even more funds experienced triple-digit gains when looking at the March 2020 to March 2021 timeframe. That’s when global markets took a hit and fell sharply as the pandemic took hold around the world, he says. Then markets “snapped back” quickly.
Many of the funds on the U.S. list had strong gains leading up to 2020, he says, including Ark Innovation ETF ARKK-A, which was up 36 per cent in 2019 and 153 per cent in 2020 – the biggest gain last year of all the funds on the list. The fund is down about 10 per cent year to date in 2021.
Another fund that experienced strong gains is American Beacon Ark Transformational Innovation Fund, which rose by 32 per cent in 2019 and 148 per cent in 2020. It’s also down about 10 per cent year to date.
Other funds on the U.S. list include Morgan Stanley Inception Fund, Renaissance IPO ETF IPO-A, and Zevenbergen Growth Fund - Institutional Class.
In Canada, three ETFs from Emerge Canada Inc., subadvised by Ark Investment Management LLC, made the list of triple-digit gainers: Emerge Ark AI & Big Data EAAI-NE, Emerge Ark Genomics & Biotech ETF EAGB-NE, and Emerge Ark Global Disruptive Innovation ETF EARK-NE. Year to date, these funds are down by 11 per cent, 18 per cent, and 16 per cent, respectively.
The Canadian fund with a whopping 318-per-cent gain was the 3iQ Global Cryptoasset Class A, an open-end fund that rose amid the bitcoin craze. It’s up 76 per cent year to date.
Many of the funds on the lists are thematic funds, Mr. Tam says, adding that most are focused on the tech sector. Specifically, a few other funds on the list delve into blockchain, big data, global innovation and auto innovation.
“They tell a story, but it’s going to be tough to make money long term and the chances of them doing so is slimmer than buying a more traditional fund,” he says, adding that their fees can be higher. “They tend to charge a premium.”
Mr. Ptak’s research showed that of the 123 U.S. equity funds that gained more than 100 per cent in one year between 1990 and 2016, just 24 made money in the three years following that large gain. In fact, the average fund lost about 17 per cent a year afterward.
“Those are sobering statistics,” he says. “It’s an indication that you need to take a close look and understand what it is that’s propelled the fund to these huge gains and understand what risks they’re courting.”
While Mr. Ptak didn’t examine if these big-gaining funds pulled in more investor dollars after the run-up, he expects that’s the case.
“I know from examining flows, investors chase performance and flows tend to happen on a lag. So, in these situations, it stands to reason that these funds were successful in gathering assets after they ripped off these huge gains,” he says. “The problem is that trouble lurked, and performance turned down. That’s why it’s so hazardous to chase performance.”
The pattern is that funds with big gains often have a narrow investing focus that’s recently found success, then that area runs into trouble, and so does the fund, Mr. Ptak explains.
“When you have a fund that’s focused on a narrower part of the market performance is likely to be streakier,” he says. ‘There’s a greater likelihood to reap big gains, there’s also the risk that you’ll suffer very large losses. It’s an anomaly to see equity funds that are unleveraged produce triple-digit gains.”
Determining to invest in a fund based on its past performance is “a bad idea,” he says. “You want to focus on a much more encompassing set of factors.”
That includes examining the fund’s investing strategy to determine if it fits a portfolio and investment goals, the management team, as well as its fees and market price.