Small Fund Firms, Strong Stewards

If you're the type of investor whose eyes glaze over when the subject of fund company stewardship comes up, a recent Morningstar report on the topic may help change your way of thinking. Among the report's findings is that firms with high rates of manager tenure, retention, and investment in the funds they manage--all key components of the Morningstar Stewardship Grade for funds--tend to perform better for investors than those without these attributes. For its criteria, the study uses a firm's success ratio, which is based on the percentage of fund share classes that survive and outperform their peers over time.

Some investors may assume that good stewardship is the exclusive domain of a select group of larger mutual fund companies. For one thing, these companies may be able to pay managers more and thus have a built-in advantage when it comes to retaining talent, one of the components of the stewardship grades. But that's by no means the case. In fact, the study found that smaller firms tend to have higher retention rates than larger ones, attributing this to the fact that many smaller firms are sole proprietorships or provide managers with an ownership stake in the firm. On other measures, larger firms do tend to provide an advantage, including offering lower-cost funds and funds run by managers with more experience in their current roles (also known as manager tenure).

These and other factors, including manager incentives, regulatory issues, the quality of the firm's board, and its corporate culture, help determine its Morningstar Stewardship Grade (you can read more about this metric here). For the largest 20 fund firms, Morningstar assigns a stewardship grade of A, B, C, D, or F. For smaller fund firms (those not in the top 20) a Parent Pillar grade of Positive, Neutral, or Negative is assigned. (Larger firms with stewardship grades of A or B are given a Positive rating, those with C are rated Neutral, while those rated D or F receive a Negative Parent Pillar.)

While the Fidelitys, Vanguards, and  T. Rowe Prices (TROW) of the fund world tend to get the lion's share of the praise when it comes to acting in the interests of shareholders, some smaller firms do the same. And even though some of these smaller fund companies charge fees that are above-average relative to their peers, there are exceptions.  

To prove that good stewardship and reasonable fees can come in small packages, we looked for fund companies with the following criteria: $25 billion in assets or less, a Positive Parent Pillar rating, average manager tenure of at least 10 years (on an asset-weighted basis), high levels of manager investment in their funds*, and below-average fees**.

The list is by no means comprehensive, and funds from the following firms are not necessarily any better or worse than those from larger firms with similar profiles. But for investors who tend to ignore funds from smaller shops, perhaps in part because of stewardship concerns, the names below provide a starting point for additional research. All the firms below offer no-load funds.

Berwyn     
Total Net Assets: $3 billion | Average Manager Tenure: 12.2 years | Average Fee Level % Rank: 48    
Medalist funds:  Berwyn (Silver),  Berwyn Income (BERIX) (Silver)
The firm has been shareholder-friendly, charging expense ratios that are reasonable given their modest asset bases, says Morningstar senior fund analyst Greg Carlson. Carlson also likes the fact that the fund's management team invests heavily in its three funds and the fact that Berwyn Income, the firm's main source of inflows, closed to new investors in late 2010 when its team couldn't find new investments.

FMI Funds       
Total Net Assets: $10 billion | Average Manager Tenure: 12.4 | Average Fee Level % Rank: 45    
Medalist funds:  FMI Large Cap (FMIHX) (Gold),  FMI Common Stock (FMIMX) (Gold)
Morningstar analyst Michelle Canavan Ward says the firm's long-term focus, collaborative environment, and shareholder-friendly behavior have resulted in superior performance. All of the investment personnel research stocks as generalists, enabling each of them to actively debate the merits of stocks under consideration and assist in decision-making. The firm has closed funds to new investors when asset growth has threatened to impede their processes--as with the now-closed FMI Large Cap and FMI Common Stock.

FPA      
Total Net Assets: $25 billion | Average Manager Tenure: 16.6 | Average Fee Level % Rank: 32  
Medalist funds:  FPA Crescent (FPACX) (Gold),  FPA New Income (FPNIX) (Silver),  FPA Perennial (Gold),  FPA Capital (Silver)
FPA is a fine steward of capital, with a strong corporate culture and clean regulatory history, says Dan Culloton, Morningstar's associate director of active funds research. The firm occasionally closes funds to new investment when needed, and instituted redemption fees to deter market-timers and short-term traders long before it became common practice. Culloton also praises the firm's "highly informative and frank shareholder communications, its low fees, and its managers' top-tier investments in the funds they run. 

Mairs & Power   
Total Net Assets: $5 billion | Average Manager Tenure: 14.6 | Average Fee Level % Rank: 35   
Medalist funds:  Mairs & Power Balanced (MAPOX) (Silver),  Mairs & Power Growth (MPGFX) (Silver)
This Minnesota firm focuses on companies based in the upper Midwest and is careful to hire people with local roots who share its long-term investing approach. The firm launched its third fund, Mairs & Power Small Cap (MSCFX), in 2011, adding career path options for its investment team. Its older funds have Fee Level ratings below their peer averages.

Selected Funds     
Total Net Assets: $6 billion | Average Manager Tenure: 18.9 | Average Fee Level % Rank: 45        
Medalist fund:  Selected American Shares (SLASX) (Bronze)
The firm's funds are advised by Davis Advisors, and the Davis family and the firm's managers and employees have more than $2 billion invested in them. Culloton says this encourages the firm to keep costs low and to communicate candidly about mistakes made and lessons learned. Despite some recent departures at the firm, Culloton says Selected "still has a solid staff and the hallmarks of a fine steward."

*Defined here as having at least 90% of assets held in funds in which at least one manager has $1 million invested

**Based on the average Morningstar Fee Level ranking among the firm's funds

Fund net assets as of March 31, other data as of Dec. 31