Morningstar Advisor - Spring 2007 - (Page 35)

Analyze the Candidates: Don’t Get Snowed You’ve completed your initial screens, and you should have a manageable universe of candidates. Now, you’re ready to get into some real number crunching. First, acquaint yourself with the data by generating a report of each fund remaining on your list. For example, in Advisor Workstation you can create a Snapshot Report, which gives a quick overview of the fund, including strategy description, risk/return statistics, and contact information. You can convert the report to a PDF document for easy printing. But you can only learn so much about a fund by looking at its risk and return numbers in isolation. You’ll understand more by running a returns-based analysis on the fund. Even though hedge fund returns are often marketed as “absolute,” it’s always beneficial to compare a hedge fund to its peers or a relevant benchmark. 6 0.72 0.07 7 create more-specialized views to show only the data points you want, such as: Monthly historical returns, rolling returns, or cumulative returns Historical risk/ reward profile of a fund Alpha compared with a benchmark Market risk using beta Tail risk, using skewness and kurtosis 2003 2004 2005 2006 Take your analysis further by creating Graphs that illustrate a fund’s performance against other funds or a benchmark. Informative graphs to create include: Historical, rolling, or cumulative returns Historical risk/ reward A drawdown analysis The correlation of a fund to the equity market 0.64 0.86 0.83 0.85 0.62 0.68 0.64 0.74 0.44 3 4 0.87 0.94 0.70 0.87 0.58 5 0.07 –0.03 –0.07 –0.11 –0.03 In Advisor Workstation, a peer group can be a category average, for example, or several individual funds in the same strategy. The benchmark could be the three-month Treasury bill for a market-neutral fund, the S&P 500 for a directional equity fund, and the Lehman Aggregate Bond Index for a fixed-income fund. You can also choose the Dow Jones Hedge Fund Index for an overall hedge fund perspective, or the Dow Jones Long/Short Equity Index for a more specific comparison. Once you have settled on a peer group or benchmark, you are ready to run reports that compare the fund’s risk and return information with its peers’. This is easy to do in Advisor Workstation. For example, you can add a peer group or benchmark to your list of fund candidates. You can then select prepackaged views of your list that highlight sets of data, such as monthend returns and quarter-end risk. Or you can As you’re conducting this analysis, inferior funds will become apparent and fall by the wayside. When you get down to a solid list of candidates, and armed with your reports and graphs, you should feel prepared to contact the managements of the funds. You want to hear firsthand about their strategies and investment style, and restrictions placed on investors. You also want to verify your data and any assertions made by management or its marketing. You’ll learn more about a fund by comparing it with peer groups and benchmarks and creating graphs of the results. MorningstarAdvisor.com 35 http://www.morningstaradvisor.com

Table of Contents Feed for the Digital Edition of Morningstar Advisor - Spring 2007

Morningstar Advisor Spring 2007 Features Departments Letter from Joe Mansueto Get to Know Morningstar’s Fund Managers of the Year Is Your Client a Stock or a Bond? Less Alpha, More Beta Than Meets the Eye Your Mileage May Vary A Clear-Eyed Look at Hedge Funds Lower Risk, Higher Returns, What’s Not to Like? Without Cash and Clout, Advisors and Clients Get Short End of Stick Get the Strategy Minus the Headaches Analyzing Funds of Hedge Funds Not All Hedge Funds Are Created Equal A Fund with a (Long) View Laying Low and Prospering A Menu of Ideas to Fill Five Market Baskets Oil and Gas Gushing with Values Mutual Fund Analyst Picks Undervalued Stocks Most Popular Variable Annuities What’s New at Morningstar and on the Web You Can’t Always Get What You Want

Morningstar Advisor - Spring 2007

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