Methodology

Developing the Klein Fund Ratings

The weighted factor model that forms the basis of KFR was created using our K⁴ Fund Selection software specifically to rank funds according to performance persistence. The KFR model has a total of three filters and four factors, each factor having a unique importance weighting.  Initially funds are segregated by style and risk level to isolate market-related performance. Funds are first grouped based on capitalization (large, mid, and small) and then by style (blend, growth, and value).  Within each style category, Klein Fund Ratings offer three risk categories-- conservative, moderate, and aggressive. based on 3-year betas vs. the category index as follows: Conservative:  Beta < .85,  Moderate: 85 <= Beta < 1.15,  Aggressive: Beta >= 1.15.  
 

The style and risk categories for KFR are shown below. The moderate risk category was used to develop the ActiFindex Risk Adjusted Return Indexes. Click here to view the ActiFindex Risk Adjusted Return Indexes.

 

	KFR Categories US Domestic Equity
		Growth	Blend	Value
	Large cap	Aggressive Moderate Conservative	Aggressive Moderate Conservative	Aggressive Moderate Conservative
	Mid Cap	Aggressive Moderate Conservative	Aggressive Moderate Conservative	Aggressive Moderate Conservative
	Small Cap	Aggressive Moderate Conservative	Aggressive Moderate Conservative	Aggressive Moderate Conservative

 

Filters Used in Klein Fund Ratings

The KFR use three filters to assure the comparison is only among comparable funds.

• Assets > $10 million

• Beta within 15% of category index beta

• 3-year R² > 80 vs. category index

The first filter requires at least $10M in assets, eliminating extremely small funds. The second filter eliminates funds that do not have comparable risk levels relative to their category index. This is an important step to minimize return differences stemming from varying levels of beta.  Finally, the third filter requires the fund to have an R-squared of at least 80 relative to the category index. This verifies the style consistency, eliminates concentrated funds and improves the statistical significance of other variables used in the process.

Factors Used in Klein Fund Ratings

Once the model assures we are looking at comparable funds, they are then scored on four factors weighted by importance. Research indicates these factors are particularly useful in analyzing performance persistence. The importance weightings are quantified using K⁴ Fund Selection's patented trade-off process. The factors and relative importance are as follows.

 

	Importance Weighting                           Factor
	Highest	FEES Expense Ratio A substantial body of research indicates that lower expenses will contribute to better performance while higher expenses pose a significant detriment. Although fund returns are typically reported net of expenses, higher expenses will always act as a performance drag that must be overcome before net alpha can be generated.		Klein Fund Rating
	Second	RETURN Return -1-year +/- category index  Evidence suggests that a "hot hand" effect can occur and contribute to persistence of positive short to intermediate term performance. In other words, recent outperformance is a relevant contributor to future outperformance, particularly in the short to intermediate term. Segmenting funds into peer group categories based on style and risk isolates the style and risk based contributions to performance that can favor "hot styles." Moreover, the R2 filter described above minimizes the instance of fund benefiting by moving away from their style.
	Third	RISK ADJUSTED RETURN Alpha- 3-year period; category index  Several studies have found persistence of alpha, both positive and negative, over short to intermediate tie periods. Even though style and beta criteria form boundaries, there is still some variance in the risk among funds within a category. The return factor rewards outstanding performance irrespective of risk, but this factor rewards only those funds that perform well after adjusting for the market -relative risk (i.e. beta)
	Fourth	RISK Worst Year- 3-year period This factor is calculated by identifying the worst 12 consecutive months that a fund has experienced over the last three years. It's inclusion incorporates downside potential by penalizing funds with poor stretches of performance. Even though it has the lowest importance, an extremely bad 12 months can lower a fund's overall ranking.

 

Klein Fund Ratings and Klein Fund Ratings Historical Tests are based on past performance. Past performance is not an indicator of future performance. Investors and advisors should consider the Klein Fund Ratings as only a single factor in making investment decisions. The information contained herein is not represented or warranted to be accurate, correct, complete, or timely. Klein Decisions, LLC, shall not be responsible for investment decisions, damages, or other losses resulting from use of this information.