3 Funds That Hit for Power

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. As we enter the homestretch for the 2021 baseball season, Morningstar has developed a "slugging percentage" for U.S. stock funds. Joining me today to discuss some of the funds that hit for power is Megan Pacholok. Megan is a fellow fan of the Chicago White Sox and an analyst with Morningstar's Global Multi-Asset Funds Research team.

Hi, Megan. Thanks for being here today.

Megan Pacholok: Thanks for having me, Susan.

Dziubinski: Let's start out by talking a little bit about what's the value of understanding what a fund's slugging percentage is?

Pacholok: Right. Well, a fund's slugging percentage is another performance metric that any investor can add to their scorecard when evaluating a fund. If you think about it in baseball terms, slugging percentage helps differentiate two players that may have a similar batting average--let's say, 300--but one of them will consistently hit a single, whereas another will hit maybe consistently a double or even a home run. That can have a different impact on the game in key situations. The same goes for comparing two funds against their benchmark. Let's say you have two funds, and over a certain time horizon, they both outperformed the benchmark over the same number of months. It's also important for an investor to know how much they outperformed by because one fund can outperform by a small margin, while the other one is consistently crushing the benchmark. So that can play a role in how an investor is thinking about adding that fund into their portfolio and setting expectations.

Dziubinski: So then, how did you go about creating the slugging percentage? What goes into it?

Pacholok: The slugging percentage--we calculated it for active U.S. equity funds over the past 10 years through June 30. In order to do that, we looked at monthly returns for a fund. And when it had a positive excess return compared to the most relevant benchmark of its category, we stacked it up against other funds within that category that also had a positive excess return for that particular month. For each month, we then assigned a fund a score. So, for funds that were in the top 10% of outperformers, they scored a 4 because we considered them to hit it out of the park. The next 20% scored a 3, the next 30% a 2, and finally, the bottom 40% of outperformers scored a 1. We then summed the total number of points for a fund and divided it by the number of months that we evaluated. And that was how we came about the slugging percentage.

Dziubinski: And then from a Morningstar Category perspective, which categories had the highest slugging percentages, and then maybe which ones didn't have such great slugging percentages?

Pacholok: Right. Out of the nine categories that make up the equity style box, the small-cap growth category actually had the highest median slugging percentage. And we didn't find that too surprising, because, according to Morningstar's Active/Passive Barometer, they found that active funds within that category had better chances of outperforming their passive peers. On the other side, the U.S. large-cap blend, large-growth, as well as mid-blend categories, all had similar median slugging percentages; however, they were at the bottom end of the spectrum. If you look at the large-blend category, as an example, they had one of the lowest slugging percentages, but they also had one of the lowest median batting average. And that just meant that funds within that category in general had a hard time beating their benchmark, the Russell 1000 Index. That index has been historically known to be hard to beat. And some might call it the Cy Young of benchmarks.

Dziubinski: Let's talk a little bit now about some of the highest-rated funds--that Morningstar gives high fund Analyst Ratings to--that also really have solid slugging percentages. The first being Gold-rated Vanguard Primecap VPMAX. Now that fund was the top slugger in the large-blend category. Right?

Pacholok: Right. So that category, as we mentioned earlier, didn't produce the highest sluggers. But Vanguard Primecap differentiated itself and actually produced an impressive 1.47 slugging percentage. That fund is run by a stable and talented team at subadvisor Primecap Capital Management, and they really implement a long-term, high-conviction contrarian approach to investing.

Dziubinski: Another top slugger and highly rated--Silver-rated Morgan Stanley Institutional Advantage MADSX had the greatest slugging percentage among funds in the large-growth category.

Pacholok: That's right. And that fund impressively also had the widest margin between its slugging percentage as well as the median for its category. It's run by veteran manager Dennis Lynch. And he really looks for names that are dominant within the market or have a high strong network effect. And they were actually one of the first to include private placements within their fund and have recently said that they would consider popular cryptocurrency bitcoin.

Dziubinski: And then lastly in the category with the biggest sluggers of all, Bronze-rated Virtus KAR Small-Cap Growth VRSGX is the biggest of the biggest when it comes to slugging.

Pacholok: That's right, Susan. So that fund in a category of big sluggers produced an impressive slugging percentage and also over that same time horizon had an excess return over its benchmark of 6.8%. It's run by comanagers that have a best idea portfolio, and most of the assets actually reside in the top 10 stocks.

Dziubinski: And one thing that's interesting is that some of the funds with the highest slugging percentage don't actually earn very high Morningstar fund Analyst Ratings. Why is that?

Pacholok: That's because slugging percentage is a historical performance metric. That doesn't take into account the magnitude of losses when a fund doesn't outperform. Meanwhile, Morningstar Analyst Rating is a forward-looking assessment that really looks at a wider range of factors including the fund's management team, their process, as well as the fund's expenses.

Dziubinski: Well, Megan, thank you so much for your time today. We really appreciate talking about this fresh approach to looking at funds. I'm Susan Dziubinski with Morningstar. Thank you for tuning in, and go White Sox!