Investors should quit assuming choosing an active fund is easy (or just quit), writes Morningstar’s Jeff Ptak.
I recently had the chance to visit with some users of our research, who asked for the one thing someone should look for to identify an active fund that will succeed in the future. It's a simple but very good question, one we get a lot.
The short answer is that there isn't any one thing, and that's why, to be blunt, most investors should probably index, not hunt for active funds.
Identifying a successful active fund in advance turns on numerous, subjective factors, and the importance of these factors can shift around over time. (More on that in a minute.) This alone is usually too much for most people to handle. Add to that the fact that even the winningest funds slump and investors, lacking the resolve to stick with it, bail. Take those two together and it argues that active-fund selection belongs in what Warren Buffett has called the "too hard pile." (Note: This also applies to advisors and institutional investors--who sometimes sneer at the impulsiveness of individual investors.)
As most readers know, we have rated funds for a number of years, attempting to separate winners from losers in advance. We've distilled that approach down into five pillars--Parent, Process, People, Price, and Performance--which act as organizing principles for our research and culminate in the forward-looking Morningstar Analyst Ratings that we assign. We're asking ourselves questions like:
> Parent: Is this an investor-centric organization or a business out for itself?
> Process: Is the strategy prudent and how will it hold up if it succeeds and assets flood in?
> People: How talented, committed, and deep is the team charged with managing the money?
> Price: Is the fund's expense ratio low enough for the manager to add value?