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K4 Fund Selection lets you quickly and easily build weighted factor models to evaluate and monitor mutual funds and ETFs. Listed below are the scoring factors, filters, and weights for this model. This illustration is for Large Cap Funds, but it can easily be adapted for other capitalizations, or equity categories.
Basis for Model Design
Mutual fund portfolio managers have it tough.
They’re about the only people in the world who have their
daily performance posted every night for all to see.
Not only that, they’re expected to consistently beat an
unmanaged index despite cash inflows, redemptions, and most
importantly, their own fund’s expense ratio. Under these circumstances,
they’re unlikely to keep up with the benchmark much less exceed it.
That’s why some managers have concluded that
the only way to beat a benchmark is to not be the benchmark.
That seems fairly obvious, but oddly enough, it’s not what
many investors want. Instead, they prefer the security of broad
diversification which typically means holding many more investments than the fund's
manager would truly prefer. It forces the manager to buy not
only his or her best ideas but a lot of others as well.
It’s also a major contributing factor to many funds’ mediocre performance.
Some funds, however, do allow the manager to
focus on a limited number of holdings. Lacking broad diversification,
they are often considered “risky” or “aggressive”, and are generally
equity funds. Some advisors search for this type of fund not only with the
belief that they have the best chance of beating their benchmark
but also to differentiate their offerings from those of their
competitors. This can be a winning combination.
Obviously, returns and the total number of fund holdings are
important, but you’ll also want to include factors limiting risk and
assuring consistency. It’s also a good idea to look for funds that
have a track record of 5 years or more and managers with a similar tenure.
Concentrated funds can be volatile and are extremely
dependent upon their manager’s ability and experience; you don’t
want to rely on a novice.
More specifically, batting average, periodic, or rolling period returns can be selected as
attributes to emphasize consistency. Down market ratio or
Morningstar Risk can be used to gauge downside protection. Once the
scenario is complete, filters can be used to assure a high level of
fiduciary standards and to eliminate those closed to new investment.
By simply changing the category elements (e.g., large cap value to
small cap growth), the same analysis can be applied to different
styles and capitalizations.
| Categories |
Selections |
| Product Type |
Fund |
| Asset Type |
Stock |
| Track Record |
5 Years |
| Domestic Equity |
Large Cap |
| Criteria |
K4 Factor |
Weight |
| Long-Term Return |
5-Year Return +/- Primary Index |
Highest |
| Downside Protection |
5-Year Worst 3 Months |
Medium |
| Consistency |
5-Year Negative Months |
Lowest |
| Risk-Adjusted Return |
5-Year Sharpe Ratio |
High |
| Filter |
Limits |
| Average Manager Tenure |
> 3 Years |
| Total Number of Stocks |
Minimum: 10 Maximum: 50 |
| Closed to New Investors |
No |
Results
After applying the filters, the highest ranked
funds will have displayed consistent 5-year risk-adjusted returns
exceeding the benchmark. Because we are considering large cap funds
regardless of style, the return comparisons are to the “primary index,” the S&P 500.
Because the funds can be drawn from growth, value, or blend
styles, the other factors aren’t tied to a specific benchmark to
allow direct comparison. The Sharpe Ratio is a measure of risk-adjusted return.
The 5-Year Worst 3 Months is a measure of the magnitude of
the worst 3-month loss while Negative Months gauges the frequency of
losses. All of the funds hold 50 stocks or less and are open to new investors.
K4 Fund Selection users can access the Analysis, Comparison, and Fund Profile
Reports for additional research. It’s almost certain that this
scenario will turn up some funds you haven’t previously considered.
When it’s time to review the funds, K4 Fund Selection users can simply copy
and rename each scenario with the current date. When you open a
copy, you can proceed directly to the results page and view the
updated data. The update is automatic with no data downloads or information to set up. You can then
compare the current results to those in the original scenario. This
is also a simple means of creating an ongoing archive of your
analyses to track the funds over time.
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