Because past performance is no guarantee — or even an indication — of future results, it would make sense to pick a fund on criteria other than past performance.
That is what C. Thomas Howard believes. And while he has been shouting from the rooftops for more than five years that fund performance is best predicted by analyzing the specific actions of portfolio managers, only recently have people started to pay attention.
Mr. Howard, chief executive and director of research at AthenaInvest Inc., prefers single or lead portfolio managers instead of management teams because a team “might force you to look at something that's not important to you.”
“Part of what makes a manager good is his idiosyncratic view of the market,” said Mr. Howard, a professor of finance at the University of Denver, who confessed that he didn't think that active management actually worked until his research confirmed otherwise. “There are lots of ways to make money, but we want you, as a manager, to do it your way.”
By Mr. Howard's calculations, the best funds and the best fund companies aren't necessarily the ones with the biggest brand names or the biggest marketing budgets.
In fact, he argues that many of the trappings of a large organization, such as budgetary and distribution pressures, can hinder a manager's ability to generate positive returns.
With that in mind, Mr. Howard prefers to study mutual funds and portfolio managers by starting with the underlying investments.
In a process that began several years ago as an academic study of the traditional style box grid that categorizes market capitalization and growth versus value strategies, AthenaInvest replaced the style boxes with 10 strategies.
The strategies are competitive position, economic conditions, future growth, market conditions, opportunity, profitability, quantitative, risk, social considerations and valuation.
The competitive-position strategy, for example, is made up of funds that invest in companies with such traits as high-quality management, defensible market positions and a track record for innovation.
A top-rated fund in that strategy (earning four out of five diamonds, which is Athena's performance indicator) is the Monetta Mid-Cap Equity Fund Ticker:(MMCEX). The $9 million fund, managed since 1993 by Robert Bacarella at Monetta Mutual Funds, has gained about 4.4% since the start of the year; it gained 33.2% last year.
The year-to-date performance compares with an 11.2% gain by the Morningstar Inc. mid-cap-growth category, placing the Monetta fund in the 96th percentile.
Last year, the fund, which Morningstar gives two out of five stars, ranked in the sixth percentile in a category that produced an average return of 24.6%.
The reason the fund ranks so highly on the Athena platform is that it meets the criteria of having a well-defined strategy, consistency and conviction, Mr. Howard said. And he knows this because on a monthly basis, AthenaInvest analyzes the more than 300,000 stocks held by more than 3,000 equity mutual funds.
The ownership of the equities, combined with the information publicly available on each mutual fund, allows AthenaInvest to categorize both stocks and funds across the 10 strategies.
“A good competitive-position manager, for example, will tend to gravitate toward competitive-position stocks,” Mr. Howard said. “The more stocks you buy in your own strategy, the better off you are.”
DEFINING STYLES
The tricky part is that stocks become part of a strategy based on how fund managers in a particular strategy invest, and not the other way around.
For example, death care service provider Carriage Services Inc. Ticker:(CSV) is a quantitative-strategy stock because it is widely held by quant strategy fund managers.
Thus, quant fund managers aren't investing in Carriage Services because it is a quant strategy stock; it is a quant strategy stock because they are investing in it.
Of course, there is a risk that as the AthenaInvest process becomes more widely recognized, efforts could be made to game the system by following the lead of the herd in a particular strategy.
“That's a tipping-point issue, and we're not there yet,” Mr. Howard said.
Identifying managers that concentrate on stocks in their own strategy aids diversification, he said.
“By and large, most portfolio managers are good stock pickers, but we want to find the least-constrained stock pickers.” Mr. Howard said.
Questions, observations, stock tips? E-mail Jeff Benjamin at [email protected].
