(PUB) Investing 2015

8

Stewardship Roundup Morningstar Research | Bridget B. Hughes

cultural deficiency that has made it difficult for the fund company to attract, nurture, and retain invest- ment talent, or did a recent merger temporarily upset retention figures? Unfortunately, the industry numbers on manager investment aren’t as strong. On average, less than half of a firm’s assets are in funds in which at least one manager has more than $1 million invested, and there are simply too many funds in which its manager doesn’t invest at all. That’s too bad for fund- holders, as Morningstar research has shown that funds with high manager coinvestment have produced better results, particularly on a risk-adjusted basis. Among the top 20 , this advantage is shown through American Funds’, T. Rowe Price’s, and Dodge & Cox’s strong success rates. (T. Rowe Price’s manager coinvestment jumps when its 401 (k) investments, which are collective investment trusts that mirror its mutual funds, are included.) One firm that goes against the grain here is Vanguard. Its manager coinvestment overall is fairly weak on the surface, but its index fund managers tend to be named on multiple index funds. When those invest- ments are combined, its manager coinvestment looks better. Plus, the vast majority of Vanguard’s actively managed, subadvised funds have high levels of manager investment. Fidelity Changes Approach, Gets an Upgrade Morningstar has seen something of a transformation on the equity side of Fidelity. The firm has long been regarded not only for its equity-research prowess, but also for its intensity and competitiveness. These latter attributes had a couple of undesirable effects. One, they created a number of star managers at the firm. While this isn’t a bad thing in and of itself, at Fidelity it meant that some of its research may have benefited a more limited group of funds rather than the organization overall. Also, key-man risk was abundant. Two, there was a lot of turnover among the funds, as Fidelity tested new managers on its smaller, noncore funds to see if they could produce results before either promoting them to more-diversified offerings

It can take time for organizations to change— especially big ones. But as Morningstar analysts have been conducting regular reviews of some of the largest mutual fund families during the past year, they’ve noted changes at some firms that have led to an improvement or deterioration in parts of their Stewardship Grades, some of which have meant a change to their overall stewardship assessment. Evolution of Stewardship Longtime FundInvestor readers and other mutual fund investors will remember how unsettling and costly the market-timing and late-trading scandals were in the early 2000 s. Morningstar felt it, too, and our stewardship efforts were born more than a decade ago. Over time, the methodology has evolved—whereas it first focused on individual funds, for example, it has since mid- 2011 concentrated on the firm level, given how critical that corporate culture is to stewardship. In a nutshell, Morningstar evalu- ates five areas to determine a firm’s Stewardship Grade: Corporate Culture, Fund Board Quality, Manager Incentives, Fees, and Regulatory History. Industry Snapshot It’s important to have some context surrounding the firm-level data that analysts use in making their judgments. Table 1 gives investors a glimpse into the industry and helps build that context. Note that companies with greater manager-retention rates have generally produced better results. But the differences in retention rates can be slight—a great majority of firms boast manager-retention rates greater than 90% . In fact, the averages are around 92% for both the one-year and five-year time periods. Thus, it’s important for investors to further investigate retention rates below 90% . Is there a