New Tools for Investment Team Evaluation

Successfully judging a fund manager is hard, whether the judge is a person or a machine. The qualities a Morningstar analyst seeks in manager meetings, such as the team’s depth and culture, are hard to quantify. Data like average manager tenure and manager history help, but don’t predict fund performance on their own.

Hard is not impossible, though. Morningstar’s quantitative team identified several useful metrics to inform the algorithmically derived People Pillar of the Morningstar Medalist Rating, which rates thousands of strategies that Morningstar analysts do not formally cover. 

Two data points drive the People Pillar rating: One measures how often a manager has succeeded over their career, the other by how much. Both are now available to Morningstar Direct users for their own analysis.

Fund companies often advertise a fund’s since-inception track record. Use this with caution. Managers come and go, and someone who left years ago may have built those glittering long-term results. Meanwhile, a fund-level number entirely misses a manager with decades of success elsewhere who runs a fund with a single year of history. 

Morningstar addresses both conundrums with a measure that follows the manager rather than the fund: Fund Manager Successful Experience, which constitutes about two-thirds of the model’s People score.

We calculate it by looking at every fund a manager has run over the past decade (including those from other firms), counting the months those funds beat their respective Morningstar Category indexes, gross of fees, and subtracting the months they trailed.

To score highly, a manager must win often and have lasted long enough to pile up winning months. A newcomer with one strong year tops out near 12; a veteran with a decade of success can score far higher. 

Tenure and skill count only when they coalesce, which is the point, since either alone can deceive. (For funds with multiple portfolio managers, we average their values and weight them according to their tenure. We presume a long-tenured manager has more influence on the fund than a recent one.)

Using the number well requires nuance. The raw counts say nearly as much about asset classes as about managers. In Exhibit 1, bond categories routinely deliver higher figures than equity categories, reflecting that broad US large-cap index funds tend to be far harder to beat than bond indexes.

That’s why Morningstar Direct offers two versions of the data point. One gives the net successful month count as a raw figure. The other, “Ranked,” counterpart scores each manager within their own cohort—their Morningstar Category Region (such as US), filtered by broad asset class (such as fixed income)—comparing bond managers with bond managers and stock-pickers with stock-pickers.

Frequency of outperformance says only so much. A manager who beats the index by a hair each month is not the same as another who consistently beats it by wider margins, adjusted for risk. To capture the magnitude and efficiency of manager success, we use the information ratio, the other primary component of the algorithmic People Pillar rating. 

Measured at the manager level over one, three, and five years (with the most weighting on five years), it divides the annualized excess return over the category index of all a manager’s funds by their tracking error, or the spread of the performance difference between those vehicles and their benchmarks. 

Morningstar tested a battery of risk-adjusted measures and selected the information ratio because it effectively predicts subsequent results and performs well across asset classes. 

For managers with short track records, the model uses the Average Brand Information Ratio, an equal-weighted average of the gross-of-fee information ratios of the entire fund family's funds. 

Three other inputs affect the People Pillar score, acting only at the extremes. A fund incurs a small penalty if its firm ranks in the worst decile worldwide for retaining its managers (Average Brand Retention Ratio 5-Year) or for the tenure of its longest-serving leads (Average Brand Longest Manager Tenure). 

Both hint that the management team might not stick around for the long haul. The fund earns a bonus when managers invest more than half a million dollars of their own money in the fund (Max Manager Ownership), as disclosed in regulatory filings—an investment level that has been correlated with stronger results. 

Morningstar's quantitative team put these metrics to the test. At each month-end from 2012 onward, the team sorted the funds into a category group by a data point into five equal buckets, from best to worst, then tracked each bucket's return over the next 36 months, gross of fees, and measured it against the category average. 

We use gross returns because the Price Pillar considers fees. Sorted by Fund Manager Successful Experience and by Manager Information Ratio, the strongest quintile beat the weakest across US equity, fixed-income, and allocation funds. 

Monthly sorts from 2012 onward show that funds in the highest Fund Manager Successful Experience quintile usually outpaced those in the lowest quintile over the next 36 months. The line chart shows each quintile’s excess returns on a rolling basis. The bar chart shows the average subsequent 36-month annualized gross excess return for a Fund Manager Successful Experience quintile across all monthly tests from 2012 to 2023. Data covers all US-domiciled open-end mutual funds and exchange-traded funds across US equity, fixed-income, and allocation funds. 

Taken together, measuring how often fund managers outperform and by how much can help find talented ones. There’s more to what makes a fund worth owning. Another crucial element is the firm around the manager: whether it charges fair fees, keeps its people, and demonstrates success across its fund lineup. Read about that here. 

Put investment team data to work. Use Morningstar Direct’s new People Pillar data points to evaluate manager experience, compare investment teams, and uncover insights for your own analysis.