(PUB) Investing 2015

2

The Large-Growth Conundrum Continued From Cover

The Large-Growth Roller Coaster

p Large-Growth Outperformance Rate

p Average

p Median

80

70

60

50

40

30

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014

Data as of 12/31/2014. What percentage of large-growth funds beat the Russell 1000 Growth Index over the trailing 10 months? As you can see, it varies by a tremendous amount. We hit a low ebb in 2003, a high point in 2008, and now we are back to an even lower point than in 2003. The horizontal lines represent the average and the median rates of outperformance.

What all that means is that boom-and-bust cycles are more dramatic in large growth than anywhere else. And when it goes bust, the Russell 1000 Growth Index gets crushed as it is heavily tilted toward high-priced stocks. It is no accident that the index was most beat- able during 10 -year stretches that ended in or shortly after bear markets and was hardest to beat after long rallies. Go back to 2000 , when CNBC ’s Jim Cramer declared that funds beating the S & P 500 were unimpressive. They had to beat the Nasdaq 100 to impress him. Of course, that would have led him to the most aggres- sive growth funds out there just in time for the bottom to fall out. The second reason for the category’s mood swings is lack of purity. While the index is a rather pure expression of large growth, most funds in the category are not. Many managers have broader mandates than large growth and so own a fair amount of the adjoining style boxes: large-blend, mid-blend, and mid-growth. In a year when small caps or value are leading the charts, actively managed large-growth managers can easily beat the index. But when it’s all about large- growth stocks like Apple and Gilead Sciences GILD , many funds get left behind.

While I’ve covered the extremes, it’s also worth looking at the creamy middles. I looked at 15 10 -year periods, and the average time period saw 49% of large-growth funds beat the index. Or, you could select the median, in which 41% beat the index. That sounds about right to me as it seems unwise to bet on nearly half the funds beating the index. What’s the Upshot for Investors? Clearly, the Russell 1000 Growth Index is an imperfect measure for many large-growth funds. Look at a fund’s performance relative to its large-growth peers as well as to the index to gain a better perspective on whether the manager has added value. You can see that in our data fields where we show category rank. If we apply this standard to actively managed funds in the Morningstar 500 ’s large-growth category, we find 17 funds that beat both the index and category. I used the 10 -year Sortino ratio rather than straight 10 -year returns because Sortino is a risk-adjusted measure and I didn’t want to simply reward high-risk funds this long into a bull market. I also used category rank to throw out any subpar performers. Because fundamentals such as manager, strategy, and fees are more important than past returns, I’ll throw in the additional screen of requiring that a fund receive a Morningstar Medalist ranking. That throws out one