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Starred Attractions Don't Guarantee Satisfaction
Russell Research Identifies Star Managers to go Within Funds
Movie-goers know that glowing reviews and plentiful box-office revenues are no guarantee of a film's greatness. When the movie ends, they are sometimes left wondering what prompted all the hype.
Savvy investors understand that the same is true with their mutual fund choices. Picking a fund based on how many stars are hung on its past performance can leave them with the same empty feeling when they see actual results.
Fund ratings, in many cases, are a poor basis for decision-making. They are eye-catching and powerful marketing tools, but no rating system can accurately predict the future success or failure of a fund. The same uncertainty applies to both a five-star highflier or a stagnant one-star dog.
Multiple-star ratings may carry an aura of superiority, achievement and peace of mind, but statistics continually show, and IFIC (Investment Funds Institute of Canada) regulations stipulate, that past performance is no indicator of future results.
Russell believes that investors should pay more attention to the stars within their funds. In our own multi-manager investment approach, the stars are the money managers that made the cut in Russell's extensive research process. No matter which asset class or style is in favour at any given time, Russell's complementary blending of managers is meant to manage risk and help provide more consistent returns through all kinds of market environments.
Investors also should look carefully at what drives performance ratings. For example, in order to place in the top 10% of a fund category — earning Morningstar's five-star rating — a fund manager often must take on high levels of risk. That risk is often inappropriate for many investors, and is likely to land the fund among the bottom performers the following year.
Consider this nugget from the March 2001 issue of Kiplinger's (a monthly US-based personal finance magazine): Stock funds that began 2000 with Morningstar's five-star ranking lost 17%, on average, last year. Funds that began the year with one star gained 5%. Russell's approach looks past the starred performance to select and combine managers who have historically performed better on average on a consistent basis.
"In all fairness to Morningstar, they've never indicated that their star rankings were predictive of future performance," said Ernie Ankrim, Russell's Director of Portfolio Research. "But, can people that do portfolio selection by star ratings expect to do better than a more informed process like we have at Russell? Based on our research, I find the results are no."
Nonetheless, the Financial Research Corporation found that a strong majority of newly invested money in 2000 went into mutual funds which had garnered four- and five-star ratings, while one- and two-star funds saw cash outflows.
But attracting cash flow certainly doesn't mean the four- and five-star funds will develop staying power.
According to the US edition of Mutual Funds magazine (March 2001) "In 1999, 92% of all tech funds had five-star ratings." Of course, the tech wreck of 2000 turned many of those into lower-rated funds.
Russell promotes looking past the starred attractions and their volatility to focus instead on a forward-looking philosophy directed at long-term competitive returns.
"We make money not by chasing performance, but by seeking consistency," Russell CEO Mike Phillips wrote in a January article for Russell.com. "Not surprisingly, we've found that the less volatile a fund's return, the less uncertainty for the investor. Our goal — and one that we have carried out year in and year out — is to provide a stable yet competitive return."
That doesn't translate to consistent five-star performance but it is meant to ease the frustration of watching a previously one-star fund outperform your portfolio of one-time five-star gems.
For further information about these contents, please contact Russell Investments Canada Limited.
This is a publication of Russell Investments Canada Limited. It should not be construed as investment, legal, or tax advice. The contents are intended for general information purposes only, and you are urged to consult your own investment, legal, or tax advisor concerning your own situation and any specific investment questions you may have.
Copyright© Russell Investments Canada Limited 2008. All rights reserved. Date of first use: 3/08/01.
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