Morningstar Advisor - June/July 2012 - (Page 42)

Spotlight result, evaluating a firm’s corporate culture is difficult to accomplish using only data. Nonetheless, one of the most significant attributes that the culture score tries to measure is whether a firm is a stable organization with a tested investment process. Morningstar now calculates a firm’s average manager tenure and a five-year managerretention rate to help characterize the fund firm. Morningstar calculates firmwide tenure in two ways: a simple average of manager tenure and an asset-weighted manager tenure. Typically, the asset-weighted manager-tenure figure is higher because funds with a track record of success and more-experienced managers tend to gather more assets than funds that have a short track record and inexperienced managers. Both data points can tell investors something about firm culture and subsequent fund performance. However, for this article, we’ll highlight the simple average because it shows how likely investors are to get an experienced manager at the helm of their fund, regardless of which offering or share class they choose. We found that firms with average manager tenure of 10 years or more had a five-year success ratio of 44% and a five-year riskadjusted success ratio of 46%, compared with a success ratio of 39% and a risk-adjusted success ratio of 37% for firms with an average manager tenure of five years or less. The difference between the two groups’ five-year star rating was very small, and the low-tenure group actually scored slightly better, possibly because of survivorship bias. Measuring a firm’s performance relative to its five-year manager retention produced even stronger results. To arrive at a firm’s five-year manager-retention rate, we looked to see which managers were running the firm’s funds on Dec. 31 of a given year, and then we determined who remained one year later. We combined these annual calculations over a five-year period, which helps investors track a firm’s stability over a longer period. Firms with a five-year manager-retention rate of 90% The Success Connection by Kailin Liu To show the relationship between stewardship and performance, we gave scores to fund firms based on the four stewardship metrics discussed in this article. A firm earns a point each for having 1) an average fee percentile level of 33 or below, 2) an average manager tenure of 10 years or above, 3) a five-year manager-retention rate of 90% or above, and 4) 80% or higher of assets in funds where at least one manager has more than $1 million invested in the strategy. A firm could earn 0, 1, 2, 3, or 4 total points, forming five groups of fund firms. We then divided each point group into quartiles based on each firm’s Morningstar 5-Year Risk-Adjusted Success Ratio. The chart shows the ranges of the second and third quartiles, essentially the middle 50% of each point group’s success ratio performance. Where the two colors meet is the median. The longer the bars, the more dispersed around the median the fund firms in that group performed. Firms that earned 0 points for their stewardship had the lowest median success ratio of any point group. The firms also clustered tightly around the median. Firms that earned 1 point have a higher median success ratio as well as a higher level of dispersion. The firms that received 2, 3, or 4 points have fairly similar median success ratios, but the 2- and 3-point groups have a huge amount of dispersion around the median, meaning their funds performed inconsistently. In contrast, the 4-point group’s success ratios cluster much more around the median, showing that firms with the very best stewardship have the most consistent outperformance and survivorship. Second Quartile Third Quartile 100 80 60 40 20 Total Points 0 Data as of March 31, 2012 Total Points 1 Total Points 2 Total Points 3 Total Points 4 or higher had a five-year success ratio of 47% and a risk-adjusted success ratio of 47%, compared with 37% and 37%, respectively, for firms with a five-year retention rate below 90%. Again, there were not large differences in the average five-year star ratings between the two groups. Ready, Set, Screen points will give advisors a strong start on picking good stewards of capital for their clients. If a fund comes from a firm that meets Morningstar’s standards of low expenses, high manager ownership, high manager tenure, and high manager retention, the odds are they will be a good partner to run clients’ assets. K Kailin Liu is a mutual fund analyst with Morningstar. Paying attention to these stewardship data 42 Morningstar Advisor June/July 2012

Table of Contents for the Digital Edition of Morningstar Advisor - June/July 2012

Morningstar Advisor - June/July 2012
Contributors
Letter From the Editor
Be Worth Remarking About
How Important Is Stewardship?
From West Point to Points East
Where a Fund’s Secrets Lie
Getting Fund Directors on Board
Managers Prep for Housing Rebound
Four Picks for the Present
Investment Briefs
A Hedge Against Career Risk
Natural Gas Reaches Capitulation
Family Matters
How Good Stewardship Predicts Superior Performance
Stewardship Goes Back to the Fundamentals
On the Go for Fixed Income
Where Shareholders Ride First Class
Dangers Lurk in Exchange-Traded Notes
Stocks on Sale in a Strong Market
A Good Steward Is Easy to Find
Our Favorite Mutual Funds
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
Buffett Rule’s Biggest Losers

Morningstar Advisor - June/July 2012