Morningstar Identifies Winners Among Largest Fund Firms

The fund industry’s largest firms all have swagger. Together they control more than two thirds of the industry’s mutual fund assets, and most--if not all--are household names.

Morningstar contends, however, that not all of these industry leaders are top caretakers of capital, and a new study from Morningstar finds the firms vary on important attributes related to fund manager tenure, retention, and personal investments in fund shares. There are also significant differences in the fees they charge. The study found that among the top-20 firms, those with stronger stewardship practices have delivered better outcomes for fundholders.

Morningstar offers a more in-depth analysis of firms’ care of capital through its Morningstar Stewardship Grades for fund firms, which analysts assign to the top 20 asset managers as measured by total mutual fund assets under management. The Stewardship Grades consider Corporate Culture, Fund Board Quality, Manager Incentives, Fees, and Regulatory History--the same methodology that determine a firm’s Parent rating, which is incorporated into individual funds’ forward-looking Morningstar Analyst Ratings. But the Stewardship Grade and Stewardship Reports delve into the details of the five components that make up the overall grade, whereas the Parent ratings feature an overall rating and summary.

Morningstar calculates firm-level data to support the qualitative research that goes into assigning Stewardship Grades and Parent ratings. These data provide additional insight into the fund industry’s mega-firms and show interesting differences between the firms earning A, B, and C grades.

To be sure, these are very small peer groups—only four firms earn A Stewardship Grades, for example—but the firms with A Stewardship Grades have longer-tenured managers, higher longer-term manager-retention rates, higher manager ownership of fund shares, and lower fees. They also have been more successful, as measured by the Morningstar Success Ratios and Morningstar Risk-Adjusted Success Ratios. These success ratios consider how many share classes a fund firm offered at the beginning of the measurement period, and then tally how many share classes both survived and outperformed, based on category rank and a risk-adjusted category rank.

Interestingly, there are marked differences in the investment approaches and business strategies of the four A firms. Each of those firms, however, have had stable lineups and have not had to merge away many--if any--trendy funds that failed to attract investors or perform competitively, an attribute that helps the firms’ success ratios by limiting the size of the denominator.

Vanguard, which is mutually owned and offers its funds at cost to investors, charges rock-bottom fees that help bring the peer group’s average down. What’s more, the firm's lineup of funds is largely passive, and indexed funds have outperformed actively managed funds in recent years, which is a boost to the success ratios. The firm’s actively managed funds have also been winners.

Dodge & Cox, a smaller firm in terms of investment offerings and staff, is notable for its long manager tenure and high manager ownership, lifting the peer-group averages. Its success ratios are uniformly high, even though its slim lineup of concentrated value-leaning offerings suffered horrible losses in 2008’s market crash.

T. Rowe Price, a broadly diverse active-management firm, has less-competitive data relative to the other A firms when it comes to manager tenure, manager ownership of fund shares, and fees, but relative to the industry, it’s still very strong. The firm mentors its portfolio managers well, and its manager-ownership data has dropped as the firm has moved its own retirement plan to collective investment trusts rather than mutual funds.

American Funds has suffered the worst performance of the four firms from a success-ratio standpoint, but it still beats the typical firm earning a B or C Stewardship Grade—especially over the longer term. Its value-leaning strategies have been out of style, but its firm-level stewardship data remain compelling, especially asset-weighted manager tenure and manager ownership of fund shares.

The six firms receiving B Stewardship Grades exceed the industry’s standard for care of capital. All have comprehensive lineups of funds that span asset classes, though PIMCO is primarily known for its fixed-income strategies. All have notable strengths, but a few weaknesses that surface in the data prevent them from receiving Stewardship Grades of A.

For example, Dimensional Fund Advisors has no manager with more than $1 million invested in a single strategy, though managers at the firm are named to multiple offerings and their combined ownership—and exposure to the firm’s enhanced-index strategies—may exceed $1 million. DFA looks much stronger when it comes to fees, landing in the industry’s lowest decile for firm-level fee average.

Fidelity’s manager-tenure numbers are the weakest among the B stewards, which is a symptom of some of the performance challenges at the firm’s equity funds and its tendency over the years to rotate managers through its funds. Its offerings, however, are competitively priced, and manager ownership of fund shares has been improving.

Franklin Templeton is a firm known for its stable management ranks, which is reflected in its high asset-weighted manager-tenure figure and five-year manager-retention rate. Meanwhile, its managers are investing at the industry’s highest level to a greater extent than the other firms earning B grades for stewardship. There’s room for improvement when it comes to performance: Less than half of the firm’s lineup has survived and outperformed its peers, including the risk-adjusted test.

Invesco’s performance looks even worse than Franklin Templeton’s, but its longer-term success ratios are affected by the firm’s 2010 merger with Van Kampen. After the two firms joined, Invesco merged away dozens of offerings, keeping the best strategy when two overlapped. This process benefited fundholders overall, and the resulting fees across the firm are fair but not rock-bottom.

MFS has produced some strong performance across its lineup in recent years, especially over the five-year period, which now excludes 2008’s market crash (though the firm performed relatively well in 2008 overall). The firm’s manager-tenure numbers are not as strong as those at Franklin Templeton or at some of the A stewards, but the firm grows its own management talent. MFS’ firmwide data would be helped if those skippers invested as robustly in their funds as some top competitors.

As of Jan. 31, the final firm earning a B is PIMCO. It has launched several new funds in recent years as the firm has branched away from its core bond funds and into equities and multiasset strategies. Such moves can depress a firm’s equal-weighted manager-tenure figure, but the firm’s asset-weighted manager-tenure average reflects the importance (in terms of size) of flagship PIMCO Total Return and that strategy’s long-tenured lead manager, Bill Gross. (Morningstar lowered PIMCO’s Stewardship Grade on March 18 to a C from a B primarily because of senior-level departures at the firm.)

Half of the industry’s largest firms get C Stewardship Grades. Morningstar maintains that, overall, these firms care for fundholders’ capital at the industry standard. While there may be pockets of relative strength within these firms’ funds, the Stewardship Grade measures the fundholder experience across the firm’s funds. On average, the firm-level data at the C stewards are worse than those of the firms earning A and B grades, though in some cases, like the average five-year manager-retention rate, the differences between these small peer groups can be quite slim.

From an overall success perspective, however, the C stewards have lower Morningstar Success Ratios. None of the C stewards have longer-term Morningstar Success Ratios of 50% or higher, meaning fewer than half of their funds both survived and outperformed relative to category peers on a straight-performance or risk-adjusted basis. Some of the C firms, including BlackRock, Columbia, and Wells Fargo Advantage, have been through significant corporate mergers during the 10-year period, which can have an impact on the firms’ success ratios. The ratios represent a firm’s total share classes at the start of the period—the denominator—and the number that have both survived and outperformed at the end of the period—the numerator. Firms that merge funds away are at a disadvantage because they have fewer share classes at the end of the period, which drags the ratio down regardless of how well the surviving share classes performed.

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.