If you were holding an S&P 500 mutual fund in 2008 that dropped 37%, you’d likely feel that your fund should go down in history as one of the worst ever. But in reality the fund didn’t do anything wrong except to invest in a part of the market that happened to experience a calamitous decline.  And just about every large cap stock fund at the time had a similar disastrous return.  It would be inappropriate to blame the funds’ management teams for the performance of the market itself. That said, however, there have been funds that deserve to rank among the world’s greatest losers.

Not counting funds operated blatantly fraudulently such as Madoff Investment Securities, one fund that could certainly qualify as the worst ever is the Steadman Technology & Growth Fund, one of a family of funds started as far back as 1939. The Steadman funds recently came to my attention from an article by Dividend Growth Investor in ValueWalk.com.  He pointed out that ever since Charles Steadman took over management of these funds in the early 1960s, they were known as “dead man’s funds” because they were always at the bottom of the performance chart. In particular, according to the L.A. Times, the Technology & Growth fund lost nearly 90% of its value by 1998, the year Steadman died.  At that point the four remaining funds were consolidated into a single fund called Ameritor Security Trust, and it continued to limp along until ultimately being liquidated in 2011.

How did the fund and its siblings manage such poor performance during a period when the S&P 500 increased by nearly 1500%? There were several reasons.  First, the management team/investment strategy was poor.  Steadman appeared to focus primarily on acquiring the latest hot stocks, which usually results in buying high and selling low.  Furthermore the frequent transactions based on this market timing approach resulted in high commission costs and taxes on capital gains.  In addition, by constantly trading, Steadman never gave his investments the opportunity to compound over time.

Then there were the high costs charged to investors. As performance declined, investors bailed, and the asset base of the funds dwindled.  Yet Steadman and his team did not reduce expenses (including presumably their own salaries), but rather continued to pass them on to the investors as part of the funds’ operating costs.  By 1998 the annual cost per share amounted to an astonishing 14%.  Evidently they got the trustees to go along by electing them to unlimited terms, eliminating annual meetings, and delaying annual reporting.  And the fund managers didn’t appear to put much of their own skin in the game as a demonstration of commitment.  The L.A. Times reported that Steadman himself only had about $16K of his own money invested.

You might wonder why anyone would even consider investing in funds operated in such a manner and with such draconian performance. The answer is that they didn’t.  From 1988 until 1998 the fund did not acquire any new investors.  But many current investors simply failed to sell, which enabled Steadman and his family to continue to milk the funds as a source of income for themselves.  While some investors presumably stopped paying attention, a large number actually died while holding the fund.  The L.A. Times stated that by 1998 fully 40% of the accounts had been legally abandoned.  One can only speculate as to whether or not the funds’ performance had any hand in their demise.

Is there a lesson in all this? Yes!  If you are going to invest in a mutual fund, you should at the very least do several things:

• Take the responsibility to understand the fund’s investment strategy. This information is now required to be reported in a concise, readable four page Summary Prospectus. If you don’t understand it, or don’t agree with it, don’t invest.
• Do not pay too much for the fund. Cost information is also documented in the Summary Prospectus. Lipper Research reports that the average mutual fund (out of the nearly 8000 extant today) costs about 1% annually. If yours costs more, there should be a good reason. 14% is totally beyond the pale.
• Track performance at least annually. If it’s below expectations, that’s not necessarily an indication that the fund should be sold, but rather that it should be investigated further.
• Make sure annual meetings are being held. Read proxies. Ensure that the trustees are doing their jobs.

It’s easy to judge a fund simply based on its historical performance. But the SEC-mandated warning – past performance is no guarantee of future returns – is absolutely correct.  Proper due diligence is necessary not just when selecting new funds but for those you are currently holding as well.