Search This Blog

Tuesday, September 1, 2009

Style Purity Redux : Why Those Morningstar Catergories Don't Mean Much

An article on the Morningstar website illustrates the perils of owning an actively managed mutual funds. It makes clear that the categories for mutual funds are basically meaningless. In this example of the Morningstar category "international value" it is virtually impossible to know what exactly is held in the fund category. Of course that makes asset allocation difficult (to say the least). As can be seen below the international value fund could hold large allocations of cash, gold, emerging markets, or even a bet that international stocks will fall in value.

From the Morningstar Website (my bolds, my comments in bold italics)

Fund Spy

Why International Value Funds Are All Over the Map
By Gregg Wolper

International value funds aren't keeping up. Or are they? If you own one of these funds, or simply watch them as an informed investor, evaluating their performance in 2009 offers more than the usual challenge.....

Not this year. The performance gap between value and growth for foreign funds is minimal. The explanations for performance are more complicated--and therefore more interesting. (I would say frustrating...the category is obviously meaningless)

On the Upside
One reason why the Dodge & Cox fund has rebounded so strongly this year after a poor 2008 is that the managers traditionally have invested much more of the fund's assets in emerging markets than their peers. That has had a huge impact, because even though the major markets have performed quite well in the rally this year, emerging markets have soared even higher. Check out the Russia funds topping the Europe-stock category. Even after a lousy couple of months opening the year, they now boast year-to-date gains ranging from 60% to 100% through Aug. 27. Or look at the emerging-Asia category, with its own fireworks prompting similar gains. (If you wanted to keep track of your holdings in emerging markets, wouldn't you be better off just buying an emerging markets etf than trying to figure out what the fund manager "traditionally" owns)

That helps explain why Templeton Foreign
(TEMFX) is close to the top spot in the foreign large-value chart with a year-to-date return of 39.9%. Its managers have long been partial to Asia's emerging markets, in particular. As of June 30 the fund had about 20% of assets in those countries (not including Singapore and Hong Kong, typically classified as developed markets), plus another 5% spread among other emerging markets. The average emerging-markets weighting for foreign large-cap funds is only about 10% of assets. (Once again showing that the foreign large cap value cab mean just about anything)

But emerging-markets exposure is just part of the story for the outperformers. In general, small stocks have also topped bigger ones by substantial margins during this rally. That's helped Quant Foreign Value (QFVOx)which after two painful years is zooming in 2009. (So a top performing fund in the morningstar international large value category did do by....holding alot of small cap stocks)...

Then there are the international value funds that holds over 20% of their asets outside of the international stock markets:

On the Other Hand
However, many other international value funds have not enjoyed such a bounty. That group even includes a few that like to own some smaller stocks. For First Eagle Overseas (SGOVX) rose 13.6% year-to-date gain lags more than 90% of the foreign small/mid-value category, the explanation lies in caution. Riskier stocks have outperformed, and this fund didn't achieve its stellar long-term record by delving into dicey companies, preferring those with a substantial margin of safety. Moreover, it doesn't have a big stake in emerging-markets companies. And with capital preservation a key goal, it devotes more money to cash (more than 8% at the end of July) and gold-related holdings (12%) than most peers. All of these traits have held it back, in relative terms, after the first two months of 2009--just as they helped the fund stay ahead of nearly all competitors during the bear marke

The same combination of factors explains the laggard showing of IVA International (IVIOX) That's not surprising, for this fund is managed by First Eagle alumni. IVA International, too, has money socked away in gold; had an even bigger cash stake at the end of July (20% of assets) than the First Eagle fund; and had an even smaller emerging-markets position. So it's not shocking that its 13.5% year-to-date gain also sits near the bottom of the foreign small/mid-value group.

Then there is the international stock fund that took a bet against international stocks and adding another undertianty (whether or not these funds hedge the currency exporure) the same fund bet against the currencies of the countries where it invested:

Another value laggard, Mutual European (MEURX )was also held back early in the rally by a cash position, as well as a put option on a European index (that is, a bet that the index would fall). Those positions didn't last too long, though, so other reasons must be found to explain why that fund's year-to-date return lands in the Europe-stock category's bottom decile and trails the MSCI Europe Index by a wide margin. Here, as with some of the others, specific stock selection bears some blame: Its preference for conservative plays on sound financial footing was out of step with broader trends in this rally. And there's another factor here: Mutual European hedges most of its foreign-currency exposure into the U.S. dollar. With the greenback having given up ground in 2009, that hasn't helped returns versus category rivals, most of which don't follow that policy. And the index is unhedged.

The morningstar article ends with a strange conclusion:

Long-Term Outlook
The bright side for shareholders of the underperformers is that all are following the policies you'd expect them to follow. They aren't faltering because of abrupt switches of approach. If you liked their strategies before, you can rest assured that they are still adhering to them.

The same goes for this year's foreign-value winners. They haven't soared because they decided to chase hot areas that they've never before noticed. Rather, parts of their time-tested strategies have happened to be strongly in favor for about half a year now.

In fact, it's worth noting that all of these funds share that admirable trait. These offerings have long-term approaches that actually stay in place for the long term

The above doesn't seem logical to me at all. The funds share an admirable trait that they might hold 21% cash/gold, and might (or might not) bet against foreign stocks or foreign currencies ? It seems clear to me that if one wanted to structure the foreign stock allocation in a portfolio etfs and index funds are the better choice.

No comments: