Among people under the age of 35, 34% of their wealth is in a retirement account of some type. Among people older than that, almost 45% of their wealth is in some type of retirement account (or about 38% if you annuitize pensions and treat them as lump sum nest eggs that are included in the calculations.) Given that there is such a meaningful percentage of U.S. wealth invested in IRAs and 401(k)’s, and given that retirement accounts frequently mandate mutual fund investing, I have received multiple requests to start covering some of the common mutual fund offerings in retirement accounts because it inevitably becomes such a meaningful percentage of many readers’ overall wealth.
I intend to do that, and one such offering that is becoming increasingly available in 401(k)’s on the east coast and midwest is the Hartford Small Cap Growth Fund (HSLAX) which has only $900 million in current assets but has nevertheless become quite accessible since 2014.
There are two demerits that first stick out at me when I study the Hartford Small Cap Growth Fund (HSLAX): the very high expense ratio, and the very high turnover rate. The turnover rate is 70%, which means that the average stock is only in the fund for 17 months. Not only does this indicate the possibility of “trading” rather than “investing”, it can end up creating very large taxable gains that take a notable toll on your net results. It also has a sizable 1.22% annual expense fee, which means that you have to pay the Hartford management team $122 each year for every $10,000 that you invest with them.
But the premise of my inquiry was retirement account investing. If you own Hartford Small Cap Growth Fund (HSLAX) in a 401k or IRA, you are not going to be affected by the 70% turnover rate because it is a non-taxable event in tax-advantaged accounts. Also, many retirement providers, particularly the large ones, negotiate a discount so that the rate you pay in a 401(k) is much lower than the rate you’d pay if you opened up an IRA and purchased shares of the fund. If your 401(k) offers Hartford Small Cap Growth Fund (HSLAX) at an expense ratio of 0.50% or less, I would not consider the cost automatically disqualifying.
Since its inception on February 19, 2002, the Hartford Small Cap Growth Fund (HSLAX) has returned 8.11%, roughly in line with the performance that you’d get from a small-cap index fund. But because the present management team didn’t take over until May 1, 2009, the first seven years of the fund’s performance isn’t really relevant because those results are based upon the skill set of someone who is no longer having any effect on the future returns on the fund.
But during the tenure of Mammen Chally and David Elliott, the fund has returned 17.05% annually while the small-cap indices have returned 16.07%. When you adjust for fees, whether you pay the sticker rate or get a discount through the 401(k), you would have basically ended up with the same net wealth as though you had invested in a small cap index. And the technical outperformance of the small-cap index fund on a pre-tax and pre-fee basis does take away the sting of my criticism related to the turnover rate.
Unfortunately, because they took over during a recession, it is difficult to gauge the management skill of Chally and Elliott’s small-cap stock picking ability during times of economic peril. My cursory review of the fund indicates that some of these holdings are extremely volatile during recessions.
For example, the largest position in the Hartford Small Cap Growth Fund (HSLAX) is a Lake-Forest, Illinois based company that deals with automotive parts and emissions. It traded at $35 per share in 2007, fell to $1.30 in 2008 for a near total wipeout, and then marched on to $42 by 2011. How do you appraise something like that? If I were writing about individual holdings, I could issue a reminder that beta (volatility) isn’t risk and your ability to ride out storms is your greatest competitive advantage and can be nearly ignored if you have a deep understanding of what you’re doing and the liquidity to remain standing during periods of extreme hardship.
But with mutual funds, you do have to take beta/volatility into account because funds that quickly fall in value lead to investor exodus and forced selling at the lows. If Hartford Small Cap Growth Fund (HSLAX) has 70% turnover during the good times, what will the turnover look like when there is economic catastrophe and the managers of Hartford Small Cap Growth Fund (HSLAX) have to deal with not only their own natural inclination to frequently trade but also a forced hand created by their investor base?
Because the Hartford Small Cap Growth Fund (HSLAX) beats its relevant index since present management took over, I have to give the management team some praise for doing what most in the active fund industry fail to do. However, the high turnover, high fees, and volatility of holdings bothers me. The turnover can be mitigated by holding this fund in a tax-advantaged account; the high fees can be mitigated if your 401(k) has negotiated a lower rate; but I sense there is a possibility of forced selling when the core holdings fall fast during the next recession. If you see the Hartford Small Cap Growth Fund (HSLAX) on your menu of IRA or 401(k) options, it is your assessment of my last concern that will likely be controlling in determining whether this fund makes sense for you.