By Leigh Walzer
It’s summertime. You are reading this from the vacation house. Or perhaps you are at the ballgame like Professor Snowball, rooting for the Quad City River Bandits. There is no event risk on the horizon. You trust your fund managers. The portfolios can stay on autopilot until Labor Day.
As advisors struggle with the new fiduciary rules, they may wonder how frequently manager selection decisions need to be reviewed. We set out to answer the question: What is the likelihood that a portfolio left on autopilot will go bad over time.
We compared the ratings on 7000 mutual funds to see how much the probability metrics changed over time. Trapezoid’s data and models (which can be trialled at www.fundattribution.com) tell us the probability a given fund class will deliver skill over the next 12 months. For most funds, skill is a function of value-added from security or sector selection. Skill takes into account a manager’s returns each period adjusted for factor exposures and other attributes.
If you have crossed off anything mathematical from your summer reading list, you can skip the next few paragraphs. Otherwise, bear with me. Investment professionals might hope that probabilities are fairly stable, because it would imply the manager selection decisions you made years ago are still valid. And you could fulfill your fiduciary duty while working on your tan.
Actually, the probability for a typical equity or liquid alts fund today equals the probability from 9 months ago plus or minus a standard deviation of .14. (This study is based on return data through April 2016. There are a few things going on with the data and the natural rate may a bit lower.) The median fund on the Trapezoid Honor Roll has a probability of .68. In nine months’ time, roughly 9% of these funds will see the probability deteriorate to below 50%. At that level, we adjudge (taking into account the availability of lower-cost passive alternatives) you are better off dumping the fund.
If you own a fund which just barely qualified for the Honor Roll 9 months ago with a probability rating of .6, the odds we will want to dump it is 23%. On an annualized basis, you may need to change out 25% of your managers.
Some professional managers review the managers more frequently for the riskiest asset classes. But the standard deviation is just as high for long only equities as for liquid alts, suggesting you need to be just as vigilant reviewing equity managers.
Funds Upgraded or Downgraded
We present here a subset of notable funds whose outlook, as measured by FundAttribution, has changed materially over the past 9 months. We include here the institutional ticker. Our confidence in the worthiness of a fund can vary greatly by share class: very few funds in our experience are good enough to justify paying a large upfront load. However, when we re-rate a fund, the metrics for all fund classes tend to rise. The FundAttribution.com site indicates whether a particular class is good enough to make the Trapezoid Honor Roll.
Upgrades:
Category | Fund | AUM ($bn) | |
All-Cap Growth | MFS Growth Fund | MFEIX | 12.7 |
Large Blend | Columbia Contrarian Core Fund | CCCIX | 9.8 |
Large Blend | Fidelity All-Sector Equity Fund | FSAEX | 9.6 |
Large Value | Federated Strategic Value Dividend Fund | SVAIX | 14.7 |
Large Value | Invesco Diversified Dividend Fund | LCEIX | 17.7 |
Large Value | JPMorgan Value Advantage Fund | JVAIX | 10.3 |
Large Value | Nuance Concentrated Value Fund | NCVLX | 0.5 |
Mid-Cap Growth | Janus Enterprise Fund | JMGRX | 8.3 |
Mid-Cap Growth | Pioneer Growth Opportunities Fund | PSMKX | 1.3 |
Mid-Cap Value | American Century Mid-Cap Value Fund | AVUAX | 8.0 |
Mid-Cap Value | T. Rowe Price Mid-Cap Value Fund | TRMIX | 11.8 |
Foreign All-Cap Value | Franklin Mutual Global Discovery Fund | FMDRX | 21.7 |
Foreign Large Blend | American Beacon International Equity Fund | AAIEX | 2.7 |
Foreign Large Blend | First Eagle Overseas Fund | SGOIX | 15.0 |
The Fidelity All-Sector Equity Fund (FSAEX) and T. Rowe Price Mid-Cap Value Fund (TRMIX) funds are closed to new investors and some other funds/strategies have experienced AUM growth.
Some of these funds have been upgraded by Morningstar in recent months. Funds which have risen in our estimation but have not been upgraded by Morningstar include JPMorgan Value Advantage (JVAIX), Pioneer Growth Opportunities Fund (PSMKX), and Franklin Mutual Global Discovery Fund (FMDRX).
Funds whose metrics have been downgraded included:
Category | Fund | AUM ($bn) | |
Large Growth | Sequoia Fund | SEQUX | 4.9 |
Large Growth | Touchstone Sands Capital Select Growth Fund | CFSIX | 3.4 |
Foreign Large Blend | Dodge & Cox International Stock Fund | DODFX | 51.6 |
Foreign Large Blend | Templeton World Fund | FTWRX | 4.4 |
Foreign SMID Blend | GMO Foreign Small Companies Fund | GMFSX | 1.0 |
Pacific Region | Matthews Asian Growth and Income Fund | MICSX | 3.1 |
Eq/Bond Global | GMO Benchmark-Free Allocation Fund | GBMFX | 15.6 |
Eq/Bond Global | GMO Global Asset Allocation Fund | GMWAX | 2.7 |
Eq/Bond Global | Wells Fargo Absolute Return Fund | WABIX | 7.4 |
Eq/Bond Global | Wells Fargo Asset Allocation Fund | EAAIX | 4.0 |
Dynamic Alloc | PIMCO All Asset All Authority Fund | PAUIX | 8.4 |
Dynamic Alloc | PIMCO All Asset Fund | PAAIX | 19.2 |
Confidence in portfolio managers is hard to earn and easy to lose. The woes of Sequoia Fund (SEQUX) have been documented at length by my colleagues over the past few months. Sequoia and Touchstone Sands Capital Select Growth Fund (CFSIX) both had steep falls from grace. Both Dodge & Cox International Stock Fund (DODFX) and Templeton World Fund (FTWRX) fell off the honor roll. The three GMO funds on this list the and two Wells Fargo funds are managed by the same personnel. GMO’s poor performance has shaken management’s faith in its managers so much that it is in the process of replacing the stock pickers with a quantitative approach. Quantitative investing seems to be coming more in vogue, but it was not the salve at two PIMCO funds managed by Rob Arnott
I was a bit surprised to find Matthews Asian Growth and Income Fund (MICSX) on the downgrade list. Several Matthews funds including Matthews Pacific Tiger Fund (MIPTX) are fixtures on our Honor Roll. Matthews manages several funds with similar names which take rather different investment approaches to the Pacific Region. We observe MICTX missed out on on India in recent years and carried too much exposure to Industrials.
Our conclusion:
Good managers go through bad patches or long stretches with merely average performance. Even after a careful manager selection process, the data next year won’t always validate the original decision. Fiduciaries should review all managers annually and be prepared to change up to one quarter of mandates. Generally, you should look for returns which justify expenses, taking into account risk, factor exposures, consistency, and fluctuations in expense ratios. FundAttribution monitors all funds, making it easy to identify whether other active funds in the same space who may have earned their laurels since your last review.