(PUB) Morningstar FundInvestor

November 2013

Morningstar FundInvestor

9

How many other funds list gold bullion as a top hold- ing? Plus, given the fund’s emphasis on minimizing risk in absolute terms, it often holds prodigious amounts of cash, which is nearly 22% of assets. Finally, as with the Longleaf funds, First Eagle Over- seas’ profile matches that of its domestic sibling, First Eagle U.S. Value FEVAX . Following a similar approach, large-blend First Eagle U.S. Value recently had an active share of 88% (versus 73% for the group median) relative to the S & P 500 Index and a five-year tracking error of 6 . 3% versus the 4 . 5% group median. But high active share and high tracking error don’t always go together. Artisan International Value ARTKX is a case in point. It has one of the highest active shares in the group at 94 . 3% , but its five-year tracking error is below average at 5 . 1% . The fund’s high active share owes to a fairly compact portfolio with 50 or so stocks. But its moderate tracking error is somewhat of a surprise given that cash tends to build (it’s currently 11% ) when the team can’t find bargains, and its sector weightings often deviate from the benchmark. Impact of Size? The aforementioned intrafamily consistency runs in the other direction, too. Among domestic large-blend funds, American Funds Fundamental Investors ANCFX and American Funds Investment Company of America AIVSX both had below-average active share relative to the S & P 500 , at 64 . 0% and 67 . 0% , respectively. Likewise, foreign-equity siblings Amer- ican Funds International Growth and Income IGAAX and American Funds EuroPacific Growth AEPGX both sported below-average active share results, at 76 . 7% and 68 . 1% , respectively. In fact, American Funds EuroPacific Growth’s active share was the lowest in our sample. With nearly $ 115 billion in assets, it’s hard not to notice that the fund is also the largest competitor, with no other offering even half its size. The contrast even shows with smaller sibling American Funds International Growth and Income. That fund is a fraction of EuroPacific’s

size with just more than $ 7 billion in assets. However, it also has a narrower mandate than EuroPacific, so that might account for some of its higher score. But EuroPacific’s gargantuan asset base must make it harder for the fund to differentiate itself from a capi- talization-weighted benchmark such as the MSCI All Country World Index ex USA . A Better Describer Than Predictor American Funds EuroPacific Growth provides a poten- tial counter-example to active-share fans. Despite having below-average active share, as well as below- average five-year tracking error ( 4 . 5% versus 5 . 5% for the group median), the fund’s nearly 7 . 2% annual- ized five-year return through September beats that of both the MSCI index ( 6 . 3% ) and the foreign large- blend average ( 5 . 9% ). This isn’t to argue that active share isn’t an important measure, but more that investors shouldn’t draw hard and fast conclusions based on this metric alone. It certainly should be included in the mosaic an investor builds when evaluating a fund, but there is more work to be done to understand these metrics and how best to use them. We plan to further explore the utility of active share and tracking error in the months and years to come, all with the goal of helping investors learn more about what is driving a given fund’s performance and why. A Dimension That Active Share Misses Although active share sounds like a measure of how active a fund is, it doesn’t capture the trading side at all. Two funds with the same portfolios would have the same active share even if one had 5% turnover and the other had 300% turnover. Buy and sell strategies are crucial to a fund’s success, and the rate of trading certainly tells you a lot about how active a fund is on that front. œ Contact Kevin McDevitt at kevin.mcdevitt@morningstar.com