Funds' Success Not Just A Fluke

7/20/2009


 

At the risk of stating the obvious, some fund managers are just better than others. One way to find top-flight managers is to simply compare fund returns. But smart investors factor in risk and performance-related metrics. To uncover effective portfolio managers, we looked for four key attributes:

Positive alpha. Alpha gauges the value a portfolio manager adds — or subtracts. The metric reflects the difference between a fund’s actual returns and its expected performance, as estimated using beta (a measure of sensitivity to market movements). The calculation is tedious, but you can find the figure at www.morningstar.com.

A positive alpha indicates a manager performed better than expected given the fund’s beta, while a negative alpha suggests a manager underperformed. For example, an alpha of 1.0 means a fund outperformed the beta-based return estimate by 1.0%. Alpha relies heavily on beta, which is only useful when much of a fund’s performance can be explained by movements in the broad market.

Lower volatility. To reward portfolio managers for keeping risk in check, we screened for funds with lower standard deviation than peers. Standard deviation measures how widely a fund’s monthly returns vary from the average monthly return. The higher the standard deviation, the wider the expected range of performance, implying greater volatility.

Positive information ratio. This reward-to-risk ratio compares a fund’s returns above an appropriate benchmark to its volatility, as measured by the standard deviation of the fund’s monthly excess returns relative to the benchmark. The ratio, calculated by Morningstar, helps gauge whether performance is driven by savvy portfolio management or taking on extra risk.

Solid, consistent relative performance. We looked for funds with three- and five-year returns above category averages. We also looked for funds that outpaced averages in at least two of the last three years.

The four top picks listed above, all members of our recommended fund portfolios, rank well based on all four of these measurements. Standouts include T. Rowe Price International Discovery ($30; PRIDX), which ranks among the top 28% of its peer group for one- , three- , five- , and 10-year total return. Longtime portfolio manager Justin Thomson invests in small and midsized foreign companies. Vanguard Dividend Growth ($11; VDIGX) invests primarily in large-cap stocks. Portfolio manager Donald Kilbride took the helm in early 2006, steering the fund to better-than-average returns in each of the last three years. Full-term subscribers may obtain reports on covered funds on our Web site by clicking on the name of the fund in the dropdown menu above.

WELL-MANAGED FUNDS
——— Alpha ———
Information
——— Ratio ———
5-Yr. Annual.
—— Return ——
Standard
—— Deviation ——
Fund (Price; Ticker)
Fund
Category
Average
Fund
Category
Average
Fund

Category
Average

Fund
Category
Average
Category
Heartland Select Value
($19; HRSVX)
3.8
0.7
0.3
(0.1)
2.8
(0.9)
21.5
22.4
Midcap Value
T. Rowe Price Int’l Discovery
($30; PRIDX)
2.7
0.2
0.5
(0.1)
6.2
4.3
26.2
27.1
Int’l: Small/Midcap
Vanguard Dividend Growth
($11; VDIGX)
3.4
0.0
1.1
(0.3)
1.8
(2.0)
15.5
19.5
Large-Cap Blend
Vanguard Int’l Value
($25; VTRIX)
1.9
0.2
0.5
(0.1)
4.3
1.8
23.6
23.7
Int’l: Large-Cap Value

 


FORECASTS FUND RECOMMENDATIONS
— Year-to-Date —
—— % of Portfolio ——
Fund (Price; Ticker)
Return
(%)
Rank
Conser-
vative
(%)
Growth
(%)
Baron Asset ($37; BARAX)
4.7
D
6
7
Dreyfus Small Cap Stock Index
($13; DISSX)
-0.6
D
0
0
Fidelity Export & Multinational
($16; FEXPX)
8.1
C
6
8
Fidelity Leveraged Co. Stock
($17; FLVCX)
19.5
A
0
0
Heartland Select Value ($19; HRSVX)
5.9
B
5
9
Heartland Value Plus ($19; HRVIX)
1.6
C
7
8
Northern Small Cap Value
($10; NOSGX)
-6.8
E
0
0
T. Rowe Price Int’l Discovery
($30; PRIDX)
24.1
A
5
7
T. Rowe Price New Horizons
($20; PRNHX)
12.0
B
6
8
Vanguard 500 Index ($84; VFINX)
1.8
C
7
7
Vanguard Dividend Growth ($11; VDIGX)
0.2
D
8
10
Vanguard Emerging Mkts. Stock Indx
.($20; VEIEX)
31.3
B
0
5
Vanguard GNMA ($11; VFIIX)
3.0
B
6
0
Vanguard Inter.-Term Tax Exempt
($13; VWITX)
6.3
C
0
0
Vanguard International Value
($25; VTRIX)
7.2
B
8
9
Vanguard Short-Term Invest.-Grade
($10; VFSTX)
8.9
A
0
0
Vanguard Total Bond Mkt. Index
($10; VBMFX)
2.8
E
20
0
Vanguard Wellesley Income ($18; VWINX)
2.2
E
0
7
Vanguard Wellington ($25; VWELX)
4.1
D
9
10
Wells Fargo Advantage High Income
($6; STHYX)
17.7
E
7
5
* Rankings through July 14 from Morningstar, comparing performance among funds with same objectives.A = top 20%; B = next 20%; C= middle 20%; D = next 20%; E = bottom 20%. c Closed to new investors.

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