Attribution analysis reveals the stocks and sectors that drive (or hold back) mutual funds' returns.
Bill Miller (Legg Mason Value
Attribution analysis is commonly used by institutions to help explain which sectors and stocks contributed to a fund's performance. Morningstar recently added this capability to its institutional software tool, Morningstar Direct, and Morningstar's analysts plan to start harnessing its insights as we dig into fund performance. For our first foray into attribution analysis, we decided to look at large-cap funds that are Morningstar Analyst Picks and that have the S&P 500 as their benchmark. The large-cap universe is a notoriously competitive and difficult place for funds to gain an edge, making it a prime candidate for deeper study of what factors explain performance. To tune out the noise that comes with short periods, we looked back over the past five years ended June 30, 2009, and compared each fund with the S&P 500 to see which stocks and sectors helped and hurt its performance. We dropped the index and enhanced-indexed picks from the study as well as active funds that use a benchmark other than the S&P. Finally, we excluded Clipper Fund
We started off our analysis by comparing each fund's sector weightings with the index and then drilled down to see which stocks had the biggest effect on the fund's results. We then measured how much value (in percentage terms) over the index the managers added in their selections of stocks and sectors.
There are a few limitations worth noting. Morningstar's attribution analysis is based on public quarterly portfolio data and does not consider every trade a fund made, making it an imperfect tool for precise accounting of a fund's successes and failures. Therefore, the reliability of our analysis declines for higher-turnover funds such as Brandywine Blue
Stocks, Not Sectors, Rule
Most managers of our large-cap Analyst Picks focus on picking stocks as opposed to making big sector bets or market-timing calls.
Fourteen out of the 18 funds we examined succeeded over the past five years by holding large positions in stocks that outperformed the S&P 500.
Fairholme bet big on Canadian Natural Resources
The funds that score poorly for their stock picks were sunk by some of their highest-conviction holdings. For example, Oakmark Select's
Sector Bets Came in Second
Overall, sector selection was less important of a driver than stock selection for these picks. Some picks leaned into stronger sectors and avoided weak ones while others leaned the wrong way with media, financial, and energy stocks. None of our picks failed or shone because of their technology and health-care stocks. Yet these two sectors represent a large and growing portion of our pick portfolios, so we'd expect them to be a bigger driver of returns in the next five years than they were in the past five. Energy and financials were more important to a fund's bottom line. Combined, those two sectors made up 30% of the S&P 500 over the past five years on average, and returns in those sectors were very bumpy, so it's no surprise that positioning in energy and financials went a long way in explaining the performance of most of our picks, for better or for worse. Sound Shore
Energy proved to be a wild card for some funds and a disaster for others. Mainstay ICAP Select Equity and Columbia Value & Restructuring
And the Prize Goes To . . .
Vanguard Primecap, Fairholme, and Main Stay ICAP shone the brightest for both sector and stock selection. (View the related graphic here.)
These funds navigated a rapidly changing environment well, which showed up as added value for a number of different sectors and stocks.
Five-year attribution gives an interesting snapshot, but it doesn't tell the complete story for the picks. Our picks (with the exception of Jensen Fund) have all posted exceptional returns versus the S&P 500 under their managers' watch. Even those funds that didn't score as well in our attribution analysis still possess some winning combination of strategy, stewardship, management, low costs, and a long history of success.