Morningstar Advisor - February/March 2013 - (Page 61)
return of each asset class is assumed to be the
return of a broad index. A number of mutual
funds list an allocation to “other.” If a
fund’s allocation to other was more than 20%,
we removed it from consideration.
allocation exhibited less risk than their
average strategic policy portfolio benchmarks;
however, the potential risk benefit decreases
(and eventually disappears) the more tactical a
mutual fund manager is.
Our screens uncovered 458 funds for the
analysis. Because holdings data is not
available for each month for all funds, if data
was missing for a month, we used the
last available month’s allocation data as the
assumed asset-class allocation for that month.2
These results are somewhat counterintuitive.
One would expect that, in aggregate, market
timing should not lead to excess risk-adjusted
performance, because it is impossible for
everyone to outperform a well-matched
benchmark (unless all portfolio managers live
in Lake Woebegon). A reason why these
results suggest market timing has existed is
because our approach doesn’t consider
the actual assets in each strategy. While a
fund’s assets are certainly important when
considering, for example, the market-timing
intelligence of mutual fund investors, it
is less relevant when determining whether or
not portfolio managers can add value through
market timing.
Higher Returns, Less Risk
The results of both proxy tests were similar.
The average outperformance against the
policy portfolio was 14 basis points with
a standard deviation of 0.69% for the
three-proxy test. It was 20 basis points with a
standard deviation of 0.84% for the sevenproxy test. The average excess risk was
negative 9 basis points with a standard
deviation of 0.51% for the three-proxy test. It
was negative 6 basis points with a standard
deviation of 0.54% for the seven-proxy test.
These results suggest that in the aggregate the
tactical changes made by portfolio managers
have added value on both a return and risk
basis (and, therefore, on a risk-adjusted basis,
as well). Forty-eight percent of the funds
tested had higher returns and less risk than the
policy portfolio, while only 18% had lower
returns and more risk.
Another way to consider the returns is the
average monthly outperformance of the mutual
funds versus their respective portfolios.
This provides us with some indication as to the
ability of active managers to make quality
timing decisions over different market cycles
(Exhibit 4). (Because the results for the
three-proxy and seven-proxy portfolios were
incredibly similar, going forward we will only
discuss the seven-proxy portfolio results to
eliminate redundancy.)
The excess return results also suggest that
while some tactical asset-allocation decisions
may add value, the more tactical a manager
is, the less value an investor is likely to realize.
The results for the excess standard deviation
also fall along these lines. Historically, mutual
funds that had fewer changes to their
Over the time period of our analysis, the
portfolios outperformed their seven-proxy
portfolio benchmarks 52.42% of the time.
There appears to be little relationship, however,
between when actively managed portfolios
outperform their respective proxy portfolios and
the level of the S&P 500. Tactical asset
allocators typically note that their objective is
to miss the significant declines in the market
while capturing some or all of the upside.
These results show no evidence that this has
actually occurred.
Category-Level Results
Our primary analysis compared the proxy-filled
returns for each mutual fund against its
long-term proxy average. This approach,
therefore, “matched” the underlying
asset-class exposures for each mutual fund to
form a proxy that represents its average
historical exposures to the market. It may be,
however, that certain types of tactical
funds, such as those that typically have higher
allocations to equity, outperform those
with less flexibility because they have a greater
ability to change their portfolios. In other
words, more conservative managers may not
realize the same level of outperformance
because they are constrained within certain
equity allocation boundaries.
To determine what effect the relative aggressiveness of the portfolio has on the ability
of a manager to make quality tactical
asset-allocation decisions, we put the funds
into groups based on their primary Morningstar
category. The primary category is defined as
the category that the fund was classified most
often during the period. Note that this grouping
does not affect the way the returns are
calculated or how performance is compared; it
simply serves as a method to let us group funds
based on their relative aggressiveness.
Conservative-allocation funds typically have
between 20% and 50% allocations
to stocks; moderate-allocation funds have 50%
to 70% allocations to stocks; aggressive-allocation funds 70% to 90% to stocks; and
world-allocation funds have at least 10% of
2 This portfolio “replication” approach yields a coefficient of determination (R²) of 85.4% to the actual mutual fund monthly returns; a median coefficient of determination
of 90.3% for the seven-proxy portfolios; an average coefficient of determination (R²) to the actual return of 84.2%; and a median coefficient of determination of 89.7%
for the three-proxy portfolios. While the correlation of the proxy returns to the actual mutual funds are noted here to describe the historical similarity in the returns, the actual
mutual fund returns were not used in the analysis because the goal of this research is determine the intelligence of the historical broad, tactical asset-class decisions made
by mutual fund managers.
MorningstarAdvisor.com 61
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Table of Contents for the Digital Edition of Morningstar Advisor - February/March 2013
Morningstar Advisor - February/March 2013
Contents
Contributors
Letter From the Editor
Social Media, the Old- Fashioned Way
Do You Use Active Strategies?
Youth Appeal
How to Buy the Unloved 2013
Morningstar Managers of the Year
Investments á la Carte
Investment Briefs
Approaches to Absolute-Return Investing
In Agriculture, It’s Good to Be Strong
Yes, There Are Good Active Funds
The Decoupling
Where It Could Pay to Be Active
The Active Fund That Defies Obsolescence
The Epitome of an Active Manager
Lines of Communication
The Existence of Market Timing ‘Intelligence’
A Route to Commodities that Bypasses the Futures Market
Best Positioned for Health-Care Reform
Diversified Stock Funds That Earn Their Stars
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
A Twisted Debate
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