*This post was co-written by Cliff Schoeman (Senior Analyst), and Simon Roy (EVP, Corporate Development).

How often have you seen personal finance websites and magazines publish ‘Top 10′ and ‘Best of Year’ fund lists as ways to hook your interest? I have often wondered if these mutual fund ratings are just fun eye candy, or a meaningful input that really help individuals make considered investment decisions. A recent article by Zacks Investment Research which highlighted the Top 5 performing growth mutual funds using the fund’s year to date return serves as a good test case. You can find the article here: http://www.zacks.com/stock/news/38570/Top+5+Best+Performing+Growth+Mutual+Funds

To summarize, Zack’s found that the following 5 funds were the best performing growth mutual fund year-to-date:

After reading the article I was struck by two thoughts:

• Firstly, is year-to-date return a meaningful measure for fund performance and selection for a realistic investor?
• Secondly, are any of the top five funds a good fit for a realistic investor?

We decided to use Jemstep’s (www.jemstep.com) beta site that helps individual investors pinpoint the best investments according to their preferences, and describes why each investment is a good fit for them.

What’s your investment profile?

Each investor has unique needs and preferences and Jemstep is designed to provide objective personalized recommendations to such individuals. While no two investors have exactly the same requirements and preferences, for the purposes of this analysis we created two investor profiles: John, a ‘typical medium-term investor’ and as a counterpoint, Mary, a short-term focused investor. We then looked at the growth funds that best fit the needs of John and Mary and compared them to the Top 5 growth funds recommended in the Zacks article.

Meet John

Using the Jemstep profile builder we described John’s investment preferences including a focus on US Equity Growth funds. Given that a fund’s investment style is but one of the criteria that should be considered in evaluating a fund, we rounded out John’s profile as described below.

Fund Holding

• Geography: U.S
• Fund Type: Stocks
• Investment style and market cap: Large, Mid and Small Growth funds

Risk & Return

• Risk & Return Tradeoff: Balance between risk and return
• Age: 40 years
• Time horizon: 10 years
• Financial Security: Stable
• Measurement of Part Performance: Both a fund’s short term performance (3 years and less) and longer performance (5 years and longer) is equally important

Fees

• Load Funds: Include both load and no-load funds
• Importance of fees: Very important (ie very concerned about high fees)

Investment Amount: $ 10,000.00

John’s Results

The screen shot below shows John’s Top 10 growth funds selected by Jemstep’s personalized ranking engine out of the 2,264 available US growth funds. Each fund has a ‘Jemscore’ – an objective measure of how well each of these funds performs and fits John’s profile. The Jemscore takes into account over 70 attributes, which are in turn weighted by John’s profile. The higher the Jemscore, the better the fit. Below you can see the Top 5 funds from Zacks highlighted in green and ranked using the same objective methodology.

A few things emerge:

• One of the Zacks five performs well: One of the Zacks funds, The Sequoia Fund (SEQUX), ranks highly at number five with a Jemscore of 71 relative to the top fund’s Jemscore of 75.
• Four of the five fall below the top 30 funds: The next top fund ranks 32^nd with a Jemscore of 65 – a full 10 points below the top fund score. The remaining Zacks funds rank 196, 330 and 1213 with Jemscores of 58, 55 and 39 respectively.
• Mis-categorized Funds: The top two funds are mis-categorized as Growth Funds: You will notice the red alert indicator next to the Sequoia Fund (SEQUX) and the Hussman Strategic Growth Fund (HSGFX). This indicator illustrates that two of the Zacks funds are not in fact growth funds – the Sequoia fund is a Blend fund and the Hussman Strategic Growth fund is a Long-Short fund. Jemstep allows you to compare and rank funds across all stock categories but will indicate when you have entered a fund that does not meet the fund category you specified in your profile.
• The data shows why the Jemstep top pick is superior: When comparing the top Jemstep fund, Meridian Growth (MERDX), to the Zacks funds, it becomes apparent why the Zacks funds are not superior for John.

Not only has the #1 Jemstep fund outperformed the Zacks Top 5 funds over the longer term (10 years) and the shorter term (3 years – see performance charts above),  it also has a much lower expense ratio of 0.86%.

How have these funds done against the S&P 500 Growth Index

We thought it would be interesting to see how well each of the funds compared against the S&P 500 Growth Index, which provides a good indication of how U.S. growth stocks have performed. We looked at each of the typical measures of performance to see which funds outperformed.

Important points from the table above:

• The Jemstep #1 fund has outperformed all funds and the index over all periods with the exception of 1 year where three funds from Zacks (BCFGX, DFCIX, HSGFX) performed better.
• The Jemstep #1 fund is the only fund to have a positive return over the past 3 years; even the very defensive Long-Short Hussman Strategic Growth fund has a negative 3 year return.
• The Jemstep #1 fund carries a slightly higher level of volatility (standard deviation) than the Zacks funds and the index. However, it has the highest Sharpe ratio, indicating that investors in this fund have received better risk-adjusted performance.
• Finally, the Jemstep #1 fund is a no-load fund and carries a considerably lower expense ratio than the Zacks funds.

But what if we only focus on short-term performance?

In order to create a more ‘sympathetic’ profile for the Zacks funds we introduced Mary, whose profile is more in line with the Zacks implied short-term performance focus. Once again we analyzed how well the Zacks’s funds performed using Jemstep’s ranking engine for Mary’s needs.

Meet Mary

Mary is an aggressive risk taker. She has $ 10,000 to invest and has decided that she only wants to invest in growth funds that have shot the lights out over the past 3 years or less.

Using Jemstep’s profile builder investors can develop a profile at different levels of granularity and sophistication. As Mary is only focused on short performance we made use of Jemstep’s advanced user mode and chose the following investment preferences:

Fund Holding

• Geography: U.S
• Fund Type: Stocks
• Investment style and market cap: Large, Mid and Small Growth funds

Risk & Return

• Total Returns: Very Important
• Measurement of Part Performance: Only focus on data from the past 3 years. This includes 3 month, 6month, year-to-date, 1 year and 3 year total returns.

Fees

• Load Funds: Include both load and no-load funds
• Importance of fees: Somewhat important

Investment Amount: $ 10,000.00

Below are the results:

Jemstep’s engine has selected high performing funds that best fit Mary’s more aggressive short-term focused profile, with a different set of top 10 funds emerging. Interestingly, the overall results for the Zacks Top5 funds appear worse for Mary’s profike than for John’s more balanced longer-term focused profile. The top performing Zack’s fund is the Bryce Capital Growth Fund with a rank of 17, whose three year total return was the main factor in pulling it down in the ranking. As can be seen above, the remaining funds rank 71, 113, 451 and 1052.

The results for both profiles below, speak for themselves:

In summary

Ranking funds by just one factor, in this case return year-to-date, is an interesting investor ‘hook’, but not a particularly useful approach to guide smart investment decisions. The Zacks analysis does not appear to have selected funds that are the best fit for at least two prototypical investors’ needs and do not appear to objectively be the best performing funds even by the one year return criteria. At Jemstep, we believe that helping individual investors make the right decisions requires personalized recommendations based on comprehensive, objective analysis appropriately weighting all the performance characteristics of a fund.

To get personalized rankings for your top funds, give Jemstep a whirl at www.jemstep.com.