(PUB) Morningstar FundInvestor

February 2014 Vol. 22 No. 6

FundInvestor Research and recommendatio s for the s riou fund investo

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How Bloated Is Your Fund?

A Secondary Factor Bloat is worth factoring in, but don’t let it drive the decision you make on a mutual fund. Expense ratios, the record under the current manager, manager investment, and stewardship of the parent company are all more important determinants of a fund’s success. Having too much money to run can be a handicap, but it’s rarely devastating to a fund. You’ll see some successful funds at the top of the bloat ratio list. How I Tested the Bloat Ratio As you know, I like to gather data at the beginning of the time period and test how it did over the ensuing time period so I can simulate what an investor could have done in the real world. If you use data today and then look back, you can easily confuse cause and effect. For bloat ratio, I checked pre-expense ratio returns because I don’t want something that’s simply an indirect way of capturing fees. I tested the bloat ratio’s predictive power for 2002 – 07 returns and 2007 – 12 returns. I grouped funds into five groups based on their bloat ratios relative to their peer group. Besides returns I looked at success rate— which measures what percentage of funds survived and outperformed peers. It’s a way of incorporating funds that no longer exist. Because many failures get killed off, they can distort the results of these sorts of tests. Some Predictive Power The results for bloat ratio were mixed. It worked well for the 2007 – 12 period but was no help in 2002 – 07 . For the 2002 – 07 test, the lowest-bloat quintile had a 43% success rate compared with rates ranging from

RusselKinnel, Director of FundResearch and Editor

Fund Reports

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With a remarkable equity rally behind us, asset bloat is a concern to keep in mind. Although U.S. stock fund flows have been fairly modest overall, some funds have been awash in new money. Which funds face the biggest challenges? To answer that question, I have dusted off the bloat ratio—a measure I introduced after the great rally in the 1990 s. The bloat ratio tries to find out how much a fund has to trade and how liquid its holdings are. Put it together and you have the bloat ratio. It multiplies turnover by the average day’s trading volume of a fund’s holdings (asset-weighted). We limited it to U.S. stocks, which in turn limited us to U.S. stock funds. Thus, a fund with a 100% turnover ratio that owns an average of three days’ trading volume figures to be more bloated than one with 10% turnover and stocks averaging three days’ trading volume. The trading volume figure is calculated using the amount of shares that trade on a typical day for a stock. So, if stock A trades 1 million shares a day but a fund owns 2 million shares, then we know it owns 2 days’ trading volume. In reality it would take many more than two days to trade the stock because placing a massive order out there all at once would move the stock in the wrong direction for the fund.

LKCM Equity Institutional Loomis Sayles Bond Oakmark Global Select T. Rowe Price Growth Stock

Morningstar Research

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Announcing Our Managers of the Year

The Contrarian

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Dialing Down Your Risk

Red Flags

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Watch Out for These Hot Performers

Market Overview

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Leaders & Laggards

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Manager Changes and News

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Portfolio Matters 16 Safeguard Your Bond Portfolio

Tracking Morningstar

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Analyst Ratings

Income Strategist

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FundInvestor 500

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FundInvestor 500 Spotlight

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Follow Russ on Twitter @RussKinnel

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