Morningstar Advisor - Spring 2007 - 19

The Chase Was On In a classic case of investors chasing performance, the crowd jumped in and out of ING International SmallCap C at the wrong times. Cash Flows Growth of $10,000 total return. The higher the success ratio the better overall investor experience. The table also lists the range of stewardship grades of the funds within each family. Families with A and B grades tend to have high success ratios. Also evident in this table is the correlation between strong success ratio and asset flows. The fund families that have been attracting large amounts of net asset flow are ones that provide a strong investor experience. Conversely, fund families with net outflows are also those with a very low investor yield. After so many investors felt burned by the early 2000s, it appears that many are now favoring investor-friendly fund families that consistently produce superior investor returns. So should you automatically avoid funds with poor investor returns relative to their total returns? Not necessarily, but poor investor returns can be a red flag that a fund may be too volatile to use to your advantage. After all, if so many other investors have fallen prey to its swings, you too might time your purchases and sales just as poorly. On the flip side, the funds with the best investor returns use prudent, low-risk strategies and place a premium on not losing money. Investor returns doesn’t paint a complete picture, but it helps provide context for setting client expectations. K Christine Benz is Morningstar’s director of fund analysis and author of the Morningstar Guide to Mutual Funds: 5-Star Strategies for Success. David Kathman, CFA, is a fund analyst with Morningstar. Information in this article was taken from a presentation given by Morningstar managing director Don Phillips at the 2007 Ibbotson Asset Allocation Conference. Parts of this article also first appeared on Morningstar.com. $44,000 $30M 27,000 12.5M 0 97 98 99 00 01 02 03 04 05 06 07 10,000 ter than those of the latter. But even where the high-volatility funds had better total returns than the low-volatility funds, the low-volatility group produced superior investor returns. The link between high volatility and poor investor returns (and lower volatility and better investor returns) makes intuitive sense. After all, high-volatility funds often exhibit large short-term gains, which in turn entice investors. But such offerings often take outsized risks to score those gains, and when performance drops off, investors get spooked. Low-volatility funds, by contrast, tend not to attract fickle short-term investors with explosive gains and also do a better job of protecting shareholders’ capital during downturns. In turn, they inspire investors to hang on—or perhaps even add more to their holdings— during the lean times. In fact, a fund’s investor return can say a lot about its stewardship. While a fund company has no direct control over how investors use its funds, it can certainly exert significant influence. Some shops put out lots of trendy funds that tend to attract investors chasing whatever is hot, and otherwise do little to encourage a long-term investment perspective. Those aren’t particularly shareholder-friendly trends, and they tend to result in relatively poor shareholder returns. On the other hand, most funds with consistently superior investor returns are from shops that encourage long-term investing and discourage short-term trading. Fund Family 2005/06 Asset Flow ($mil) Investor Total Success Stewardship Rtn Rtn Ratio 1 10 Yr % 10 Yr% Grade American Funds Vanguard Dodge & Cox Fidelity 142 86 34 28 9.31 8.40 10.19 9.04 7.47 3.29 4.78 9.61 8.74 97% 96% A/B A/B A B/C B/C B/C B/C/D 9.84 104% 9.51 7.62 9.20 7.01 95% 98% 36% 68% Franklin Templeton 15 Janus Putnam -13 -34 1 Investor return divided by total return. Data as of Dec. 31, 2006. The table above shows a sample of popular fund families, ranked by asset flows, and their corresponding investor and trailing total returns for the past 10 years. We created a “success ratio” by dividing investor return by For more on Morningstar Investor Return, download the our methodology paper at http://advisor.morningstar.com/uploaded/pdf/ir.pdf. MorningstarAdvisor.com 19

http://Morningstar.com http://advisor.morningstar.com/uploaded/pdf/ir.pdf http://morningstaradvisor.com

Morningstar Advisor - Spring 2007

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