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Research Funds Aren't All They're Cracked Up to Be

They make a lot of sense for fund companies and fund researchers, but for investors?

Russel Kinnel, 09/24/2012

In recent years, analyst-driven funds have become more popular with fund companies, if not investors. Each year we see a few "research" funds launched.

The idea is to have a fund where analysts at the firm do all the stock-picking without being filtered through a fund manager so that their skills can drive total returns. Typically, these funds are run in a sector-neutral fashion in which each sector head doles out the assets to each analyst's picks. In a sense, research funds have been with us much longer than the recent trend would lead you to believe. American Funds has long handed a portion of most of its funds directly to analysts. It makes plenty of sense given how experienced its analysts are and how much money the firm has to manage.

Fund companies like these funds because it's a good way to give analysts greater responsibility and pride of ownership. It's a nice retention tool, and it gives firms real-money track records for their analysts. It also allows the company to offer another fund without requiring additional resources. If the fund produces strong performance, it is almost like found money for the fund company. The fund company can also point to strong results as a proof statement when touting the quality of its analyst staff.

As a fund researcher, I like how research funds provide me with a way to measure analysts' performance. Fund companies like to tell us how strong their research is, but they don't always back those statements up with hard numbers.

Should fund investors like research funds? The case is less certain. Experienced managers can add value through portfolio construction, by their own experience investing in a company or industry, or simply by knowing each analyst's strong suits and weaknesses and adjusting portfolios accordingly.

On the other hand, a fund manager can undo an analyst's good stock selection with bad timing or by making the wrong top-down moves, or by ignoring the analyst's advice. Also, an analyst-driven fund isn't vulnerable to the departure of one key person the way a fund with a sole manager is.

How Have Research Funds Performed?
Although I could think of some research funds with strong performance, I wanted to take a more systematic look at the group. It was important to include research funds that no longer exist so as to avoid being biased by the good funds that lasted. Poor performers that were liquidated or merged away are key to the overall picture.

I included all the ones I knew about. Then I searched for funds with "Research" in their names and read each prospectus to see if the funds really were analyst-driven research funds. There's no official designation of "research fund" in our database, so I may have missed a few funds but likely got most of them.

Russel Kinnel is Morningstar's director of mutual fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping investors pick great mutual funds, build winning portfolios, and monitor their funds for greater gains. (Click here for a free issue). Mr. Kinnel would like to hear from readers, but no financial-planning questions, please. Follow Russel on Twitter: @russkinnel.
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