How Good Is Your Fund Company?

When you’re researching a mutual fund, be sure to take a step back and look at the fund shop behind the fund. If the firm has had success running other funds with a similar strategy, that’s a good sign. It means that the analyst staff behind the fund you’re considering is probably a good one. It also indicates that the firm is doing a lot of important things well, such as attracting and retaining talented investors, introducing new funds that have produced pleasing long-term results, and applying good risk controls.

The results produced by a fund's sibilings also give you a sense of what the future of management might hold. If you’re a buy-and-hold investor, your association with the fund might outlast the current manager. The firm might elevate an analyst or look outside for their replacement. The firm’s record with other funds is a good predictor of how well they’ll do at finding a good replacement.

A Score Is Born
Getting a handle on the overall picture at a fund family isn’t easy, so we created the fund family score to help. The fund family score is an asset-weighted average of a fund company’s star ratings within one of four asset classes. A big firm like Fidelity will have different scores for its domestic-stock, foreign-stock, taxable-bonds, and municipal-bond funds.

The reason we divided the scores by asset class is that success in one area doesn’t necessarily translate into skill in other areas. For example, 10 years ago, Fidelity had great domestic-stock funds but its bond funds were crummy. Today, their bond funds are quite good, as reflected by the fund family score of 3.8. If you understand how the star rating works, then it should be pretty clear what the score means. (The scale ranges from 1 for the worst score to 5 for the best.) 

There is one wrinkle worth noting, however. Clearly, the $72 billion  Vanguard 500 Index Fund’s (VFINX) record should count for more than $540 million  Vanguard Dividend Growth’s (VDIGX) record. But when we calculate the fund family score, we asset-weight each fund's star rating using the fund’s asset base from three years ago. We use the asset figure from three years ago because it provides a better gauge of how well the firm has performed for a typical shareholder. 

Say a shop has an Internet fund and a REIT fund. Three years ago, the Internet fund had $3 billion in assets and the REIT fund had $100 million in assets. In such a case, the Internet fund’s performance would have a much greater impact on shareholders’ bottom line than the REIT fund. Today, those asset figures might be reversed because of depreciation and fund flows. So, when we calculate the fund family score three years from now, the REIT fund will carry a much bigger weight than the Internet fund.

Using the Fund Family Score
Now that you know how we calculate the fund family score, you’re probably wondering how to use it. I see the family score as a useful screen in narrowing the field. For example, you could throw out any funds with a fund family score below 2.5 because such a score could indicate the firm has structural problems.

You could use it as a positive screen, too, but I don’t recommend setting the bar above 3.5. The reason is that the law of large numbers pulls the big firms back towards the average score of 3. A shop with just three muni-bond funds is more likely to earn a score at an extreme end of the spectrum, but a large fund family with 20 muni-bond funds is going to be hard pressed to earn a score above 3.5. Remember that Morningstar awards 4- and 5-star ratings only to funds in the top third of their category. The more funds a firm has, the less likely they will all be standouts.

Finding the Fund Family Score
You can find our fund family score toward the bottom of any Fund Analyst Report. You can also use the score to screen for funds with our  Premium Fund Screener. In the coming months we’ll surface the score in a couple of other locations, so stay tuned.

Our Take on a Fund Family
The fund family score isn’t the only way we help you to analyze a firm. We also provide in-depth analysis of each major firm’s capabilities right next to the fund family score near the end of the analysis. You can find our take on Fidelity’s domestic-stock funds, for example, in our  Analyst Report on Fidelity Asset Manager  (FASMX).

Poll Update
On Monday, I asked which big growth fund would put up the best returns in a sustained growth rally.  American Funds Growth Fund of America (AGTHX) was the top vote-getter with 34% of the votes, followed by  Janus Fund with 24%, and  American Century Ultra (TWCUX) with 22%. I voted for Janus because it’s the closest thing to a pure-growth fund among the five with the largest asset bases.

In a separate poll, I asked if fund companies should sue to get a piece of the Wall Street settlement on tainted research. A whopping 69% of you said "yes."

Still More on Dividends
Warren Buffett weighed in on the dividend-tax cut debate this week with an editorial in the Washington Post. Currently, the proposal is in a conference committee where the Senate and House are hashing it out.