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Fund Manager of the Year: Morningstar's Selection Process

Tue, 14 Jan 2014

Our awards recognize managers who had a great year but also have consistently delivered for investors over the long haul, says Morningstar director of active fund research Michael Herbst.

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Video Transcript

Christine Benz: Hi, I'm Christine Benz for Morningstar.

Morningstar announces its Fund Managers of the Year each January. Here to provide a peek into the selection process is Michael Herbst, director of active funds research for Morningstar.

Michael, thank you so much for being here.

Michael Herbst: Thank you for having me.

Benz: Michael, everyone anxiously awaits these award winners. Let's talk about the selection process. It's Fund Manager of the Year, but you are not just looking at the single year's performance, right?

Herbst: That's correct. For the awards, we do want to recognize managers who we think benefited investors by executing their strategies successfully over the past year. But we're also looking for managers that have done that over the long haul.

All of our nominees and all of our winners are Morningstar Medalists, which means they've been assigned Morningstar Analyst Ratings of Bronze, Silver, or Gold. It's worth noting that that group of Morningstar Medalists constitutes just over 10% of the funds available for sale in the U.S. So, we are already picking from an elite bunch.

Benz: You head up our active funds research. You are intimately involved in this process of nominating and selecting fund managers. Let's talk about how it works. When do you start talking about who might the Fund Managers of the Year be, and then what sort of process do you use to vet them and finally arrive at the winners?

Herbst: We start actually talking about nominees and who is doing well probably in September and October. This is something that our analysts are particularly interested in, so the conversations pick up from there.

The formal process, the way it works is, we solicit nominations from across the fund research team. Anybody can select a manager for nomination. We do have asset class experts that head up the nominations in each area. So those experts will vet the nominations. Then we reconvene as a group, and we all get in the same room at the same time and review the nominations and conduct voting that way. Every analyst has a vote: one person one vote.

Benz: You are looking not just at performance, short- and long-term, but also fundamental factors. What other more qualitative factors go into determining who might be the nominees and the winners?

Herbst: As I mentioned, for all the nominations we have to select from funds that are already Morningstar Medalists.

Benz: So they are Bronze, Silver, or Gold.

Herbst: That's correct. … This is not a case of managers just being in the right place at the right time. It's also not a matter of just looking at the highest-performing funds. What we are really trying to do is take a step back and say, here's what we know about how these managers ply their strategy. What decisions did they make that contributed to such solid performance over the past year?

But beyond that, we are looking for managers that have proven successful over the long haul on a risk-adjusted basis, and we're also looking to emphasize those that have proven to be exemplary stewards of investors' capital over the long haul.

Benz: There is a rumor going around that sometimes fund managers who win the award in one year go on to underperform. I think some managers have kind of joked that maybe it's a curse to receive the award. I know that you and the team have looked at some data on that, on subsequent performance from funds that have actually won the award. What do the data show about how the funds do subsequently after manager wins?

Herbst: The rumors make for great headlines, but the data don't support the rumors. We've looked at the Morningstar risk-adjusted performance of the winners over the three-, five-, and 10-year periods after they win. And what that data suggests is, if you look at the trailing three-year period--this would be for managers who won the award in 2010 or earlier than that--20% of those managers have gone on to outperform their category averages by 400 basis points or more per year on an annualized basis. An additional 40% have outperformed their category averages by 100 basis points to 400 basis points on an annualized basis over that stretch.

The same trends carry out over the trailing five- and 10-year periods. If you look at the five-year period, just over 15% of the winners go on to outperform their category averages by 400 basis points or more on an annualized basis. An additional 50% go on to outperform by 100 basis points to 400 basis points. And that plays out over the 10-year period, too, with 15% outperforming by more than 400 basis points, and an additional 40% outperforming by 100 basis points to 400 basis points.

So generally speaking, more than half of our winners go on to outperform their category averages, not just over the subsequent three-year period, but over the subsequent five- and 10-year periods as well.

Benz: Maybe you've convinced some investors that this is something that they ought to look at and that it predicts forward-looking performance. But really how should investors use this award? Is this kind of a shopping list for the years ahead? How should investors take this award and use it in their own fund selection-process, or not?

Herbst: The Fund Manager of the Year is a big feather in the cap for all the winners and for all the nominees--so it's not insignificant. That said, it's not a predictor of future outperformance, so investors should not necessarily expect repeat performances in the years following.

I think what's more important to note here is, because these are Morningstar Medalists, all of the nominees and all of the winners are managers that we have a high level of conviction in. These would be managers that we would be comfortable recommending to investors over the long haul.

Benz: So you are saying these aren't fly-by-night managers. These are managers who we really have conviction in their process and stewardship and everything else?

Herbst: That's correct. Certainly not fly-by-night managers. These are managers that we think investors should consider for use over the long haul. What we hope is that, with the designation and with the work that goes on in determining the Morningstar Medalists, that in turn should give investors conviction to stick with these managers when they inevitably underperform.

Benz: Michael, thank you so much for being here to provide some insight into the selection process.

Herbst: My pleasure.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

 

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