Are the Morningstar Fund Managers of the Year 2010 the best for you?

CATEGORIES: Investment Viewpoints

Introduction

Morningstar recently published their Fund Managers of the Year 2010. The winners were as follows:

  • Domestic-Equity: Winner Sequoia (SEQUX) (Manager: Robert Goldfarb and David Poppe)
  • International-Stock: Winner Janus Overseas (JAOSX) (Manager: Brent Lynn)
  • Fixed-Income: Winner Templeton Global Bond (TPINX) (Manager: Michael Hasenstab).

Hearty congratulations to all the winners, each of whom is no doubt worthy of the Morningstar accolade. We decided to run these funds through Jemstep to see just how good these funds are, and if they are a good fit for all investors. Using the criteria highlighted in the Morningstar article as a guideline, we created two investment profiles – Jack and Kate – to evaluate these funds. While Jack is fairly conservative and seeks a low risk fund, Kate seeks a more aggressive, high risk investment.

For the sake of brevity, our blog analysis is confined to the Domestic-Equity category and the specific profiles are shown in the addendum at the end of this post.

Results for Jack’s low risk profile

The Jemstep fund evaluation process measures each fund against a user’s investment needs, reporting the overall performance as a numeric ‘Jemcore’ out of 100. The higher the Jemscore, the better the fund fits the investor’s needs. Morningstar’s Domestic-Equity Manager of the Year fund (SEQUX) ranked 68 out of the 6,230 available US equity funds with a Jemscore of 66 while Jemstep’s  #1 fund had a Jemscore of 76.

To illustrate the difference between the #1 and the Fund Manager of the year, in the table below we compare the following funds to SEQUX:

  • Jemstep’s top ranked fund for Jack’s profile (NSEIX);
  • another fund which ranked in our top 10 (WPFIX); and
  • an S&P 500 index fund (VFINX). We included the index fund to give you an idea of how these funds performed against a broad index.

 

Interpretation:

  • Domestic-Equity Fund Manager of the Year fund (SEQUX) comes in the Top 1%: The Sequoia Fund (SEQUX), ranks highly at number 68 with a Jemscore of 66. NSEIX, our top fund, has a Jemscore of 76.
  • SEQUX outperformed by Jemstep #1 fund in 1,3,5, and ten years: Although 1 year performance was an extremely important factor in deciding the Manager of the Year award, both the higher ranked Jemstep fund’s managed to outperform this fund over the past year. In fact, the Jemstep top ranked funds have outperformed this fund over 1, 3, 5 and 10 years. However, all the funds have strongly outperformed the S&P 500.
  • Jemstep #1 Fund outperforms SEQUX on a risk adjusted basis: It is interesting to note that the two Jemstep funds and the Manager of the Year fund have very similar expense and low risk profiles – in fact, all the funds have been less volatile than the S&P 500. However due their higher past performance the two Jemstep funds have better risk-adjusted returns, illustrated by their higher Sharpe ratios. Finally, all of the funds have a manager who has been running the fund in excess of ten years.
  • While a good fit for Jack, the Morningstar Manager of the Year fund (SEQUX) is not the best fund for him. Both the Jemstep funds and SEQUX have managed to significantly outperform the S&P 500 with lower volatility. They have proved to be defensive while still maintaining strong returns. However, Jemstep’s objective ranking engine illustrates that SEQUX is not the best fund for Jack. All three funds perform similarly in terms of fees, fund manager tenor and risk, however the two Jemstep funds have produced higher returns over both short (1-3 years) and long term (5-10 year) periods. This has resulted in these two funds providing better risk-adjusted returns.

Results for Kate’s aggressive, high risk profile

Jemstep’s rankings for the Aggressive High Risk profile place SEQUX at #1031 out of the 6,230 available US equity funds with a Jemscore of 56.

The table below illustrates the SEQUX fund performance against Jemstep’s top ranked fund for Kate’s profile. (MPEGX) together with another top ten ranked fund (HSRSX). The S&P 500 Index mutual fund (VFINX) is also included as a representation of the broader index.

Interpretation:

  • Domestic-Equity Fund Manager of the Year fund (SEQUX) only comes in the Top 17%: Note the large change in the ranking between the Low and High risk profile. SEQUX performed strongly on the Low risk profile due to its strong defensive qualities; however, it is clear from these rankings that it is not an aggressive equity fund.
  • SEQUX shows poor 1 Year Performance Compared to more Aggressive Funds: Note how the two Jemstep funds (MPEGX and HSRXS) have almost doubled the performance of SEQUX over 1 year, and have achieved over three times the performance of the S&P 500. These two funds have had an incredible year!
  • SEQUX has Long-term Consistency of Performance: The two Jemstep funds have outperformed both SEQUX and the S&P 500 over 1, 3 and 5 years. MPEGX slightly under performed SEQUX over the last 10 years due to its poor performance during the market crash in the early 2000′s, but Kate’s profile was targeted towards prioritizing shorter-term performance over longer-term performance.
  • Jemstep #1 fund has superior risk adjusted returns: As this is an aggressive, high risk profile both the Jemstep funds have carried a higher level of risk when compared to SEQUX. The higher volatility is indicated by the higher standard deviations (a measure of volatility) of these funds. On a risk-adjusted return basis (looking at the Sharpe ratio) both Jemstep funds trump SEQUX and the S&P 500, illustrating that investors have been richly rewarded for taking higher risk. Finally, both Jemstep funds have low expense ratios and have been run by experienced fund managers.
  • The other funds better fit Kate’s more aggressive investment goal SEQUX produced almost double the return of the S&P 500 index fund in the past year and it has beaten the index fund over the past 3,5 and 10 years. In short, it has performed very well in the past. However, the two Jemstep funds have trounced both the SEQUX and the S&P 500 index fund over the past 1, 3 and 5 years. Furthermore, both funds have a more aggressive investment mandate and have performed better than SEQUX when markets have performed strongly. These funds therefore carry a higher level of risk and have a higher probability of “shooting the lights out”.
  • On balance we have to say the Morningstar Manager of the Year fund (SEQUX) is not a good fit for Kate’s profile. While SEQUX has performed strongly in the past it doesn’t carry the same growth potential as the top ranked Jemstep funds, and is more defensive.

In Summary

If you were seeking an aggressive domestic equity fund with the intention to shoot the lights out then the management duo from SEQUX would probably not have been your Managers of the Year. Despite the strong performance of SEQUX, other, more aggressive funds managed to strongly outperform SEQUX last year and over longer time periods. On the other hand, if you were looking for a more defensive, low risk fund, SEQUX would not have disappointed you although there were several dozen funds that would have been better choices for your profile.

Managers Robert Goldfarb and David Poppe of the Sequoia fund (SEQUX) deserve congratulations for strong performance as recognized by the Morningstar’s Domestic-Equity fund Managers of the Year award. However, while in the past generic, one-size-fit-all fund recommendations were all that was available, Jemstep believes that in order to best serve the needs of individual investors, fund ratings should be tailored to each investor’s unique profile. While in the past this was impossible, using Jemstep individuals can now do this for themselves in minutes. It is worth noting that the analysis for this blog took less than ten minutes to run on Jemstep’s website; writing the article took much, much longer. Register with Jemstep’s private beta website and find the top funds that best fit your needs.

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Addendum – Investor profiles used in analysis

Each investor has unique needs and preferences and Jemstep is designed to provide objective personalized recommendations to such individuals. While no two investors have exactly the same requirements and preferences, for the purposes of this analysis we created two investor profiles: Jack and Kate. The key difference lies in their appetite for risk. While Jack is fairly conservative, Kate seeks a more aggressive investment. In all other respects the profiles are the same and are based on the areas of core importance highlighted by Morningstar in determining their winners.

The following key factors make up our investor profiles:

1. Importance of Performance History and Fund Managers Tenor

Morningstar said: “…We look for managers who nailed the past year on the heels of much lengthier success…”

How we interpreted it: Because Morningstar focuses on the returns over the past year we prioritized short term returns but in addition we also placed significant importance on a fund’s overall track record. Furthermore because we believe that “time at the wheel” is an important factor in determining the Managers of the Year we place high importance on the fund manager’s tenor at the fund.

2. Fund Performance – Driven by Luck or Skill?

Morningstar said “…we measure this success not only by observing trailing performance, but also by reviewing managers’ research and actions over time…”

How we interpreted it: In order to assess whether performance has been driven by skill or luck we placed importance on a range of modern portfolio statistics such as a fund’s Sharpe ratio. Factoring these stats into portfolio management ensures that the focus is not only on how a fund has performed but also on the amount of risk a fund manager has taken in order to generate a fund’s historic returns.

3. Additional Preferences in the Investment Profiles

(i) Fees

Although no mention of fees is made in the article, fees reduce the returns earned by the fund and therefore we have prioritized low fund fees in our rankings

(ii) Risk & Return Profile

Finally the Morningstar article makes no mention of a risk profile used to assess these funds which is obviously critical in fund analysis. So, as mentioned above, we analyzed the funds against our two different risk profiles:

- Jack – low risk appetite, defensive and would like to limit levels of volatility: and

- Kate – aggressive, high risk. Wants to “shoot the lights out”.

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About the Author

Cliff Schoeman is Senior Financial Analysts at Jemstep. His first and primary interest has always been in stocks and other financial instruments, and he has been actively managing investments for over 15 years.

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