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Lineage Matters: Strong Firms' Funds Stand Taller

New Morningstar study of asset managers shows good stewards have produced better funds.

New research out today supports Morningstar's view that investors should not only be mindful of what they invest in, but which firms they invest with.

Morningstar examined its data on asset-management firms offering U.S. mutual funds and found that firms with strong stewardship attributes--the highest levels of manager tenure, manager retention, and ownership of mutual fund shares--have delivered better outcomes for investors than firms with poor data. The same is true of firms that offer funds with lower expense ratios.

The study looked at data that Morningstar's analysts consider when evaluating firms for its Parent ratings and Stewardship Grades. The Parent ratings are one of five components driving a fund's forward-looking Morningstar Analyst Rating of Gold, Silver, Bronze, Neutral, or Negative. The data, along with a qualitative analysis of a firm, help Morningstar analysts determine whether a firm is likely to be a good caretaker of capital over the long term.

Morningstar measures manager tenure, retention, and investment in fund shares, as well as fund fees, at more than 750 U.S. asset managers offering mutual funds. For the study out today, Morningstar looked to see whether firms with stronger data have higher Morningstar Success Ratios, which reflect the percentage of a firm's fund share classes that both survived and delivered peer-beating performance based on Morningstar category rank and risk-adjusted category rank.

To start, Morningstar sorted firms by their funds' average asset-weighted manager tenure (larger funds are weighted more heavily in this calculation) and found that firms with the longest average manager tenure have higher Morningstar Success Ratios than firms that offer funds with the shortest average manager tenure. The data support the notion that longer-tenured managers have earned their keep by delivering better returns. It also suggests that some firms are better at keeping veteran managers around than others.

Next, Morningstar looked at the firms' five-year manager retention rate, which gives investors an idea of how effective an asset-management company has been at retaining its mutual fund portfolio managers. The manager-retention rate determines what percentage of a firm's fund managers have stayed at the company as portfolio manager, on average, over each of the past five years.

As was the case with firms with longer-tenured managers, firms that have high manager retention rates also have higher Morningstar Success Ratios. Morningstar analysts use this as a signal about a firm's corporate culture. Firms with little disruption in their fund-manager ranks are demonstrating a strong culture that attracts and nurtures investment talent. The data indicate that mutual fund parent companies that are better at retaining their portfolio managers also have delivered better outcomes for fundholders.

From there, Morningstar looked at fund managers' investments in the funds they run. Morningstar calculates the percentage of a firm's assets where at least one manager has personally invested more than $1 million of his or her own money in fund shares. The study found that firms where nearly all fund assets have more than $1 million in manager investment had the highest Morningstar Success Ratios, supporting Morningstar's earlier studies that managers who "eat their own cooking" run funds with better results than those who don't invest alongside fund shareholders.

Finally, Morningstar looked at the fees firms charge on across its mutual fund share classes. Morningstar puts the fees in context through the Morningstar Fee Level--Distribution, which ranks funds' expense ratios by an investment-objective peer group as well as its sales charges. To determine whether a firm's fund fees are cheap or expensive, on average, Morningstar calculates a firm-level Morningstar Fee Level--Distribution, which is a straight average of the Fee Level calculated for each share class offered by the firm.

True to other studies Morningstar has done on fund fees, cheaper is better. Firms with low fees overall had significantly higher Morningstar Success Ratios than firms that, on average, charge more than peers.

All told, this latest Morningstar study suggests that investors would be wise to consider a firm's stewardship metrics when picking an investment, be it a single fund or suite of investments. Certainly a firm's stewardship profile is not the only determinant of a fund's long-term success, but the data suggest that partnering with strong stewards tips the odds in fundholders' favor. Investors can get Morningstar's view of fund firms through the Parent portion of funds'  Morningstar Analyst Rating, as well as  Stewardship Grades issued to the top-20 asset managers by U.S. fund assets.

Christina West contributed to this article.

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