Things to Look at in Judging a Fund Manager
Ellen Harris, Michael Fasciano and Foster Friess are mutual fund managers.
Decent ones at that.
Harris runs PaineWebber Growth. Fasciano heads up the Fasciano Fund. And Friess is the longtime manager of Brandywine.
Over the last decade, each of these stock portfolios has done equally well.
In 1998, they went in different directions. Harris ended the year up 32.3%. Fasciano was up 7.2%,. And Friess ended the year down about 1%.
It’s easy to see that Harris made her investors a lot of money during the schizophrenic year and that Fasciano and Friess did not. But which one of these managers, if any, actually earned his or her fees in 1998?
Which ones, if any, delivered shareholder value last year?
That’s a more difficult question to answer, but an important one to ask, financial planners and mutual fund analysts say.
So how can you tell?
* First, ask yourself: What kind of fund did I buy?
When you invest in a mutual fund, you’re buying a product, like a car or a refrigerator. Remember that.
In our examples, PaineWebber Growth and Brandywine are mid-cap growth-stock funds. That means they invest in medium-capitalization companies with rapidly growing earnings. Fasciano is a small-cap growth fund, meaning it invests in small-capitalization stocks with rapidly growing earnings.
* Next, determine if your manager delivered the product you expected in 1998.
Let’s say you order a new red Mustang and the car dealership delivers a blue Ford Taurus. It’s a decent car. It’s brand-new. And it runs perfectly well. But did you get what you paid for?
If you’re a fund investor trying to determine whether your manager delivered value, take a similar approach.
Notes Hal Reynolds, chief investment officer for Wilshire Asset Management in Santa Monica: “You have to ask: Is your fund manager sticking to his or her style?”
In our example, the Fasciano Fund is a small-cap portfolio, by prospectus. And according to fund tracker Morningstar, it invested in small-cap stocks last year. The median market capitalization of its holdings is $830 million. (Small-cap stocks are generally defined as those with market caps of $1 billion or less.)
PaineWebber Growth, which you’ll find in our “Top Funds” tables on page C12, is another story. For the last six years, this $247-million fund has been a mid-cap portfolio, according to Morningstar. But in a process that began in mid-to-late 1997 and continued through 1998, the fund began shifting into large-cap stocks.
Notes Morningstar analyst Jeff McConnell: “The fund’s median market capitalization has skyrocketed since; it’s now almost three times its average peer’s.”
Indeed, whereas the median market cap for holdings in the average mid-cap growth fund is just $4.9 billion, PaineWebber Growth’s median market cap stands at $16.3 billion--well within large-cap range.
(In our charts, PaineWebber Growth is still classified as a mid-cap fund because Morningstar does not change classifications based on a single quarter or single year’s holdings. However, the fund is likely to join the large-cap ranks soon. Because Morningstar also compiled our “Top Funds” tables, the fund’s category ratings are still based on mid-cap growth comparisons.)
For its part, Brandywine ended the year as a mid-cap fund. But don’t give Friess any credit. Fearing a market correction, Friess converted most of his entire portfolio into cash in the beginning of 1998--in essence becoming a money market fund at a time when stocks were gaining. He went back to being fully invested in April, just as stocks began their descent.
* Next, find out how well your fund performed.
Obviously, this is the critical question in determining whether your fund manager earned his or her fees.
The total-return figures that your fund company quotes you--for instance, in your quarterly or annual statements (or even in newspaper and magazine ads)--reflect performance minus fees, including expense ratio and 12b-1 fees.
This means that even if your fund charges more than its peers, if it beat its less expensive peers, its raw performance had to have been much better.
Thus, performance is a great way to check relative value.
“The bottom line is how is this manager doing against his peers,” notes Bill Dougherty, an analyst with Boston-based mutual fund consulting firm Kanon Bloch Carre, stressing that “peers” is the key word.
In our example, the Fasciano Fund posted returns of just 7.2%. But compare that with the average small-cap growth fund (which gained 4.4%), and you can say with certainty that Michael Fasciano added value. His fund finished among the top 10% of its peers.
Another way to look at it is that small-cap stocks, on average, fell 2.2% last year, as measured by total returns of the Russell 2,000 index of small-company shares. Despite that, Fasciano managed to squeeze out 7.2% in gains in 1998.
Last year, PaineWebber Growth generated returns of 32.3%, putting it in the top 10% of all mid-cap growth funds.
Sounds good. But remember, with a median market cap of more than $16 billion, Harris’ fund is really a large-cap portfolio now. (Its top holdings recently included Dell Computer, Cisco Systems, Travelers Group and Time Warner.) When you compare PaineWebber Growth against the average for its actual peer group, it generated 12% less in returns than other large growth funds.
So, though in actual dollar terms the fund made its investors plenty of money, it’s hard to say that it provided that much added value this year.
It should be easy to say that Friess did not earn his fees in 1998. While the average mid-cap growth fund gained 18.1% last year, Brandywine is down 1%, putting it in the bottom 2% of its peers.
* Now factor in other costs.
For instance, you should consider taxes.
In his unsuccessful attempts to time the market, Friess jacked up his turnover rate--the rate at which a fund manager replaces stocks in his or her portfolio. (You can get this information by calling your fund company, or go to Morningstar at https://www.morningstar.net on the Internet.)
The average domestic stock fund has a turnover rate of 87%, which means it replaces nearly its entire portfolio every year. What’s Friess’ turnover rate? 264%.
Why does this matter? Generally, when a manager sells stocks, he or she realizes capital gains. Those gains are then distributed to shareholders, typically at the end of each year. And shareholders have to pay taxes on them--unless the fund is held in a tax-deferred account.
Harris used to turn over only 25% to 35% of her portfolio each year. Now, as she converts her mid-cap fund into a larger-cap portfolio, her turnover rate has tripled to 86%. Fasciano, on the other hand, has maintained a relatively low 50% turnover rate.
* What’s the conclusion?
All three managers charge relatively low fees--at least below their category averages. But one can argue that only one manager, Fasciano, clearly added value last year.
With Harris, it’s hard to say, given the fund’s style drift. As for Friess, he plainly did not.
Should you dump a fund if the manager didn’t earn his or her fees in a given year? No. Always consider longer-term performance, financial planners say. But if a fund manager consistently fails to deliver value, year after year, it may be a reason to consider selling.
Paul J. Lim can be reached at paul.lim@latimes.com.
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Are Your Managers Overpaid?
Mutual fund expenses for operations and management fees are reported as an “expense ratio,” the percentage of fund assets taken annually by the fund company. Certain kinds of funds are more expensive to run than others, so investors should compare their equity funds’ expenses with the category averages, shown below:
Category: Misc-specialty
Avg. expense ratio: 2.38%
Category: Div. Pacific / Asia
Avg. expense ratio: 2.24
Category: Pac. / Asia ex Japan
Avg. expense ratio: 2.16
Category: Latin America
Avg. expense ratio: 2.13
Category: Div. emerging mkts.
Avg. expense ratio: 2.13
Category: World stock
Avg. expense ratio: 1.88
Category: Precious metals
Avg. expense ratio: 1.88
Category: Japan stock
Avg. expense ratio: 1.83
Category: Europe stock
Avg. expense ratio: 1.80
Category: Natural resources
Avg. expense ratio: 1.78
Category: Technology
Avg. expense ratio: 1.73
Category: Foregin stock
Avg. expense ratio: 1.66
Category: Health
Avg. expense ratio: 1.65
Category: Small-cap growth
Avg. expense ratio: 1.64
Category: Communications
Avg. expense ratio: 1.63
Category: Financial
Avg. expense ratio: 1.61
Category: Mid-cap growth
Avg. expense ratio: 1.59
Category: Real estate
Avg. expense ratio: 1.54
Category: Convertibles
Avg. expense ratio: 1.53
Category: Small-cap blend
Avg. expense ratio: 1.49
Category: Mid-cap value
Avg. expense ratio: 1.49
Category: Utilites
Avg. expense ratio: 1.48
Category: Small-cap value
Avg. expense ratio: 1.47
Category: Large-cap growth
Avg. expense ratio: 1.42
Category: Mid-cap blend
Avg. expense ratio: 1.39
Category: Domestic hybrid
Avg. expense ratio: 1.34
Category: Large-cap value
Avg. expense ratio: 1.31
Category: Large-cap blend
Avg. expense ratio: 1.25
Source: Morningstar Inc.
