Popular Index Funds Perform Poorly

Searching for ways to select funds, Morningstar recently looked at Sharpe ratios as well as Morningstar's own star rating system, which relies on risk-adjusted past performance. The Morningstar researchers found that risk-adjusted past performance can have some predictive value. But the researchers determined that investors can increase the odds in their favor by considering both risk-adjusted returns and expense ratios. Funds that had low costs and strong risk-adjusted returns were likely to do well in the future.

Picking active funds requires making subjective decisions. You must strive to find funds that seem to have a sensible investment approach that is likely to thrive in the future. But by sticking with managers that have long records of consistent success, it is possible to find funds that deliver sound returns.

A top choice is Parnassus Equity Income (PRBLX), which has returned 7.4% annually during the past 10 years, outdoing 99% of its large-blend peers and topping the S&P 500 by 4.7 percentage points annually. Working hard to limit risk, manager Todd Ahlsten excels in downturns. The fund topped the S&P 500 by wide margins during the downturns of 2000 and 2008. Parnassus holds reliable performers, such as Microsoft (MSFT) and Nike (NKE).

Another steady performer is Mairs & Power Growth (MPGFX), which has returned 7.3% annually during the past decade. Manager William Frels looks for rock-solid companies that can grow consistently. Holdings include blue chips, such as cereal maker General Mills (GIS) and device maker St. Jude Medical (STJ).

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Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

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