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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 Domestic Multicap Equity, but it can easily be adapted for Specialty or Foreign equity categories.
Basis for Model Design
With the advent of the equity “stylebox,” you
don’t hear much about multicap managers anymore. They’re still out
there and many are doing quite well, but they just don’t fit neatly
into a capitalization and style category. Many investors turn up
their noses at them, thinking multicap funds suffer from the dreaded
“style drift.” Ironically, it’s the ability to freely move between
capitalizations and styles that enables multicap funds to take
advantage of changing market conditions. Unlike funds that are tied
to a specific category (even when that category is out of favor),
multicap funds can always seek out the top performing areas of the
market.
Klein Decisions’ K4 Fund Selection can help you find top
multicap funds, but the approach is a little different than
category-specific searches. Because the funds cover the full range
of capitalizations and styles, you can’t rely on category-specific
benchmarks that aren’t comparable across all categories. Instead,
this is where a broad benchmark such as the Primary Index can come
in handy. For domestic equities, the Primary Index is the S&P 500,
the gauge many investors use for multicap funds. Non-index specific
factors such as Sharpe Ratio and Standard Deviation are also good
choices.
Multicap funds show their strength over entire
market cycles. Ten-year statistics can capture this better than
shorter-term measures. To make sure that all funds can be scored on
each factor, you’ll also want to require a track record of ten years
or more. This will limit your universe while focusing on proven
long-term performers.
| Categories |
Selections |
| Product Type |
Fund |
| Asset Type |
Stock |
| Track Record |
10 Years |
| Domestic Equity |
Large, Mid, Small Cap; Growth, Blend, Value |
| Criteria |
K4 Factor |
Weight |
| Long-Term Return |
10-Year Return +/- Primary Index |
Highest |
| Short-Term Relative Return |
1-Year Return+/- Primary Index |
Medium |
| Total Risk |
10-Year Standard Deviation |
Low |
| Market Risk |
10-Beta (Primary Index) |
Low |
| Value Added |
10-Year Sharpe Ratio |
High |
| Filter |
Limits |
| Average Manager Tenure |
> 5 Years |
| Expense Ratio |
≤ 1.00 |
| Percent in Bonds |
≤ 5 |
| Percent Assets in Top 10 Holdings |
≤ 40 |
| Distinct Portfolio |
Yes |
Results
This model emphasizes long-term return and
risk, but to ensure that high-scoring funds still have an element of
momentum, it places a medium amount of weight on one-year return
relative to the S&P 500. The filters are a check on the managers and
management style. They ensure that the current manager was
responsible the majority of the results and didn’t game the equity
market by holding bonds or excessive diversifiable in
an overly concentrated portfolio. The expense ratio is limited to
minimize the drag on future performance. The distinct portfolio
filter eliminates multiple share classes, making the final rank
ordering more meaningful.
It’s important to note that there is no guarantee that this scenario will
always come up with multicap
funds; some may just be the best in their given categories.
Nevertheless, based on April 30, 2008 data, the average
capitalization mix of fund holdings was roughly 45/35/20, large,
mid, small cap, respectively. The average style breakdown is shown
on the nearby chart.
Because this model covers such a large array of
funds, K4 Fund Selection users will probably want to conduct some additional due
diligence. The Comparison Report is a good place to start,
especially in regard to the fund’s portfolio, fundamental
characteristics, and Best Fit Indexes. You might also want to
consider exporting some of these additional data points into Excel
using dummy filters (see "Filters for Dummies").
Once you’ve created this scenario, you can use
it to monitor the funds. Next month or next quarter, simply copy and
rename the scenario with the current date. When you open the new
copy, you can proceed directly to the Results page and view the most
current data. The update is automatic, and you don’t even need to
answer the questions on the Category or Preference tabs. You can now
compare the current results to those in the original scenario. This
is a simple means of creating an ongoing history of your analyses
over time.
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