Our Picks' Batting Average Is .650
Through the first quarter, our domestic-stock fund picks lead the Wilshire 5000.
It's time once more to update you on the performance of our Fund Analyst Picks. Every quarter we'll update you on how our picks have performed. The picks are a premium feature (click here to see all our picks). We choose the funds that we believe have a competitive advantage over the long term. We focus on proven success factors such as expense ratios, management, strategy, long-term performance, and stewardship.
We're different from the crowd because many investors and professionals alike focus on short-term performance. However, mountains of data suggest that short-term performance is a poor predictor of returns. Nonetheless, our most controversial picks are always those with poor one- and three-year returns and our most controversial omissions are those with great one- and three-year returns. We have the benefit of visiting with management and running data through sophisticated tools such as Morningstar Direct, whereas those doing quicker, more superficial analysis usually infer a lot about management skill based on recent performance. To them, a spate of bad performance means that management "has lost its touch," but we look at more-tangible factors to determine if something fundamental has changed.
To measure performance of our picks, we use two tools: weighted batting averages and aggregate performance versus a benchmark. The weighted batting average essentially measures our rate of success against a category average. First we ask if the pick beat the category average for the time in which it was a pick. Then we weight that success rate by the length of time that it was a pick. So, a fund that was a pick for five years counts for five times a fund that was a pick for one year. Then we roll up all those figures to come up with an overall weighted batting average. For the second measure, we aggregate the performance of our picks in a broad asset class and compare them with an index. This is closer to what you're used to seeing in the investment world because you get two return figures to compare. The downside with that measure is that in rolling up performance from different categories you may have an aggregate that differs from the index with which you're comparing it.
How'd We Do?
Our performance for the trailing three- and five-year periods ending the first quarter of 2007 was pretty much in line with where it has been since we started reporting the figures last year. Our three-year average was 70%, and our five-year average was 65%. That means that our picks have been winners about two thirds of the time over the past three- and five-year periods. We think that's solid.
Using the aggregate measure, our domestic-equity picks (excluding sector funds) returned 9.56% versus 7.76% for the Wilshire 5000 and 6.27% for the S&P 500. We're pleased with those figures, too, but recognize that market-cap bias has a hand in that success. The Wilshire 5000's average market cap is about $28 billion, whereas the median domestic-equity pick is about $14 billion. Because smaller-cap stocks have outperformed over the past five years, we've had a tailwind against the Wilshire. However, 38% of our current picks have an average market cap above the Wilshire's, so it's not a dramatic mismatch.
Drilling Down Into the Results
It's interesting to note that by asset class, the weighted batting averages show our picks have been more successful in foreign stocks, municipal bonds, and taxable bonds and less so with domestic equity. For example, 98% of our foreign large-blend picks have been winners over the past five years while just 50% of our domestic large-blend picks have been winners.
One reason for the weakness in domestic large blend is that very same market-cap effect that aided our overall domestic-equity success against the benchmarks. That's because within our large-cap picks we have a number of blue-chip funds that have had higher market caps than their typical peers. Funds such as Fidelity Dividend Growth (FDGFX), which has a $68 billion market cap, have lagged. We try to pick good stock-pickers rather than make macro calls, so we're comfortable sticking with management when fundamentals remain strong. We've also had contrarian funds such as Oakmark Select (OAKLX) moving up in cap and over toward growth stocks. The move has hurt performance, but Bill Nygren is following his discipline of buying the best companies at the biggest discounts to his estimate of intrinsic value. That kind of strategy is intended to work over the long haul, but it obviously requires patience from managers and shareholders alike.
In bondland, we've enjoyed a lot of success in core categories such as intermediate bond and muni national long where our batting averages are more than 90%. In other areas our preference for low-risk strategies has held us back. In high-yield taxable we're batting just 45% because taking on big credit risk has been rewarded over the past five years. However, we think most investors are better served with a little caution so that there is downside protection when high yield has its occasional meltdown.
Our Best and Worst Picks
To determine what our best and worst picks are we looked at our picks' returns versus the category average over the time they were a pick.
Some of our best include T. Rowe Price Media & Telecommunications (PRMTX), which returned a total of 225% since we made it a pick in July 2002 through March 2007 versus a category return of 127%. The fund had a sane strategy and good management in a category sorely lacking in both. We're reviewing the fund's status right now in light of plans for comanager Rob Bartolo to move over to T. Rowe Price Growth Stock (PRGFX). Another big winner for us has been Artisan International (ARTIX), which returned 122% versus 67% for its category average since it was first made a pick in 1999. The fund has been a pick all the way back from 1999, and Mark Yockey has done a nice job maneuvering through bull and bear alike.
Vanguard Health Care (VGHCX) has been another big winner. Ed Owens of subadvisor Wellington is one of the very best sector-fund managers around. Much like the T. Rowe fund we like this fund's mix of expertise, low costs, and sober strategy.
On the downside, our worst-performing pick has been Vanguard European Stock Index (VEURX), which returned 82% versus 151% for the average European fund since it was first picked back in 1999. The fund has lagged its peers because it is dominated by blue-chip stocks while its peers own smaller caps and Eastern Europe stocks, both of which have produced awesome performance. Once again, though, we're comfortable recommending the lower-risk and lower-cost option.
In a similar vein, American Funds New World (NEWFX) has been a weak performer for us because it is far and away the most conservative route to emerging markets. In addition to emerging-markets stocks, the fund owns emerging-markets debt and developed-markets stocks of companies with a lot of business in emerging markets. It's a common sense way to approach a high-risk area, but it clearly will lag when high-risk markets such as Russia, China, and India are enjoying huge returns.
Note on Target-Date Funds
In computing the batting averages we only count the target-date picks for each fund company as one fund in order to avoid having 10 target-date picks from one fund company overwhelm the results for everything else.
Russel Kinnel has a position in the following securities mentioned above: OAKLX, NEWFX. Find out about Morningstar’s editorial policies.