Megafund companies can seem pretty indistinguishable from one another, but a report from fund-data tracker Morningstar reveals that not all fund companies are created equally. There’s a significant difference between fund companies in terms of how their funds perform over the long term, how long their managers stick around, how much their managers have invested in their funds and how well they carry out their stewardship.
When evaluating funds, it’s easy to focus on individual funds rather than the company that sponsors them. Although this makes sense, it’s also a good idea to evaluate the company behind the fund. Studying the fund company can tell you a lot not only about the fund itself, but also about how long the manager’s likely to stay, how you’re likely to be treated as a shareholder and how your fund performs in the long run.
The mutual fund business is a very profitable one, and despite changes in some of the rules governing mutual funds, the deck’s still stacked in favor of the fund companies rather than the shareholders.
That’s why when you’re investing your hard-earned money to fund your retirement, your child’s college education or some other important goal, you want a fund company that’s going to treat you right.
These statistics are heavily weighted toward manager-related metrics. That’s because, especially for actively managed funds, the manager (or managers) is a key figure. Management-related metrics are also relatively easy to measure. At actively managed funds, the manager makes decisions about buying and selling securities. That’s in contrast to the passive investment strategy employed at index funds, for which the fund holds the securities that make up a particular market index.
The following are five ways you can evaluate your fund company and why they’re important:
As a shareholder, you’re likely invested in only one or, at most, a few funds with a particular fund company. So what difference does it make how the fund company as a whole ranks in terms of returns? It matters because it says something about the quality of fund management and how funds hold up during the long term.
To get a sense of how a fund company’s returns stack up, Morningstar examined the asset-weighted returns of the 30 largest fund companies. This method of measuring returns averages out a fund’s asset size so that funds with more assets can be compared with funds with fewer assets. In Morningstar’s analysis, PIMCO, Harbor Funds, MFS, Janus and T. Rowe Price were the top five in terms of three-year asset-weighted returns.
Although it’s better to judge a fund by a longer-term return than three years — five and 10 years make the most sense — Morningstar’s director of mutual fund research, Russel Kinnel, chose the three-year option to get a sense of how the funds in a company’s current lineup stacked up against each other. In this case, the past three years span the market downturn of 2008 and the rebound during the past year, so it’s a worthwhile way to compare fund companies.
When you’re buying shares in an individual mutual fund, you want an experienced manager who has exhibited a good track record. If a fund company has a good history of management staying put over the long term, there’s a better chance that managers at each individual fund will stay longer.
I prefer to invest in a fund with a manager who’s been there for at least five years. That way, I can be sure that the manager is responsible for at least the past five years’ performance. Although past performance is certainly no guarantee of future returns, I’d rather invest my money with a manager who has established a solid long-term track record than one who hasn’t.
The average tenure among managers in the 30 fund companies studied by Morningstar is 5.2 years. But the actual numbers vary widely.
Dodge & Cox, the highest-ranking fund family, has an astounding manager tenure rate of 10.12 years, followed by Franklin Templeton Investments at 10.05. Then there are two fund companies with tenure figures in the eight-year range: American Funds at 8.88 years and GMO at 8.29. After that, tenure rates drop into the neighborhood of six years for T. Rowe Price and MFS.
Five fund companies — Vanguard, Eaton Vance, Wells Fargo Advantage, American Century Investments and Legg Mason/Western — have tenure rates in the five-year range. The remaining 19 fund companies have average tenures of between three and five years.
Tied closely to manager tenure, this statistic tells you how successful a fund company is in retaining its managers. Obviously, the better a fund company is at retaining managers, the longer they’ll stay on the job. When a fund company can retain managers, it lends stability to the company’s overall lineup.
The top two fund companies in this category have a manager retention rate of better than 97 percent, which is pretty amazing. American Funds leads at 98.4 percent, followed by Dodge & Cox at 97.2 percent.
Both of these fund families employ a team management approach in which several managers collaborate to oversee an individual fund, versus an individual manager making all the decisions. Of the 30 funds included in the report, only nine had manager retention rates of 90 percent or above. The other 21 had rates between 80 percent and 90 percent, with the lowest-ranking fund family, Goldman Sachs, recording an 81.4 percent retention rate.
When fund managers invest along with their shareholders, they have some skin in the game. They’re putting their own money on the line, which means that their personal fortunes, to a degree, rise and fall with the value of the fund they’re managing.
So the average amount that a manager at a fund company invests in his or her own fund, or in the other funds operated by the company, is important. And it’s no accident that the same fund companies that have high manager tenure and retention rates have the largest average manager investment amounts.
Dodge & Cox wins the prize here, with an average manager investment of $860,000, significantly more than the second-place company, American Funds, with an average manager investment of $582,051. Third is Janus Funds, with an average manager investment of $517,857.
After that, the numbers drop off pretty steeply:
T. Rowe Price, which is No. 4, has an average manager investment of $219,948 and No. 5 MFS has an average of $202,698. The other 25 fund companies have average manager investments of less than $200,000, with ING Funds last at $13,633.
Morningstar grades funds on stewardship, which is made up of several metrics, including:
• Fees: Although an individual fund’s fees are more important than the fund family’s fees collectively, how a fund family manages fees overall is important. Some fund families have a reputation for higher fees and a history of increasing fees; others keep their fees low and don’t add unnecessary ones such as 12b-1 marketing and distribution fees.
• Board quality: Morningstar favors boards that are composed of 75 percent independent directors — those not affiliated with the fund company — and who have meaningful investments in the funds they oversee.
• Regulatory issues: If a fund company has had a serious recent issue with regulators, you might want to think twice about investing in it. Many fund companies were caught up in the scandal of 2002 and cleaned house as a result. There haven’t been any major scandals since, but it’s a good idea to keep your eyes open on this issue.
Morningstar grades funds on an A to F scale for each element of stewardship and gives a composite grade. You have to subscribe to gain access to the stewardship grades, but you can get a two-week trial membership for free if you just want to look up a fund family or two.
The Impact of a Parent
When evaluating a fund for potential purchase, the characteristics of the individual fund are more important than the fund company that sponsors it. But by taking a look at the fund’s parent company, you can tell a lot about the fund and its chances of thriving in the future.
Freelance writer Amy E. Buttell of Erie, Pa., covers mutual funds for BetterInvesting. She’s also the author of the second edition of the association’s Mutual Fund Handbook.
You can learn more about these rules in the How to Use the Mutual Fund Informer Guide or in the educational articles included in each issue of the Mutual Fund Informer, a new monthly mutual fund newsletter publication from ICLUBcentral that presents profiles of high-quality mutual funds with superior long-term track records. Get profiles of high-quality mutual funds at lowest subscriber rate plus sample a free issue now.