Dan Solin
Morningstar's Fund Manager of the Year: A Slippery Slope
Dan Solin
Thursday, February 16, 2012
I previously cautioned investors about the perils of relying on various lists of "best fund managers." One of the most popular of these lists is issued annually by Morningstar, which annually designates a "Fund Manager of the Year" in various categories.
Lipper, another well-known mutual fund researcher, also bestows awards on funds "that have excelled in delivering consistently strong risk-adjusted performance, relative to peers."
Presumably, investors rely on these awards as a basis for selecting mutual funds in their portfolios. This is unfortunate.
My colleagues at Index Funds Advisors studied the performance of sixteen domestic equity funds that received the "fund manager of the year" designation by Morningstar. It looked at data from the inception date of the fund manager (or, in two cases, from the inception date of Morningstar's benchmark) through 2011. Here's a summary of the findings:
Past Performance is no....(You know the rest)
Will Danoff, who managed the Fidelity Contrafund, was Domestic Equity Manager of the Year in 2007. In that year, he beat his benchmark by almost 8%. In 2009, he underperformed his benchmark by almost the same percentage.
Mason Hawkins, who managed Longleaf Partners, won the award in 2006, when he beat his benchmark by 6.17%. He underperformed his benchmark by 6.22% in 2007 and by 13% in 2008.
Every one of the fund managers of the year had subsequent years of some underperformance. Perhaps the worst example is Jim Callinan, the manager of the RS Small Cap Growth fund, who was the 1999 Domestic Equity Manager of the Year. No wonder. His fund beat its benchmark by an unbelievable 140 percent! Then Jim fell off the wagon. In six of the seven ensuing years, he underperformed his benchmark. In the only year he beat it (2004), it was by a measly 0.85%.
The Lack of Evidence of Skill
Of the sixteen funds studied, only one fund manager evidenced skill based on a statistical test (the t-test) which determines if the fund's outperformance was really attributable to skill (with a 95% or higher probability) or if it could be explained by luck. Even if you can find a fund manager who passes the test for a finite period of time, it is not a slam dunk that his skill will persist in the future.
Helpful Data from Morningstar
While Morningstar's "Fund Manager of the Year" awards are likely to mislead investors, other data it provides is worthy of serious consideration. It reported 2011 inflows of passively managed long-term funds of $76.4 billion in 2011. In sharp contrast, actively managed funds had net outflows of $9.4 billion. Clearly, investors are getting the message. Still, the overall market share of actively managed funds, as reported by Morningstar, is 85.2 percent compared to 14.8 percent.
You want to be part of 14.8 percent. I call those investors the educated minority.
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