Mutual Funds: Portfolio Structures, Analysis, Management, and Stewardship

CHAPTER 9

The Morningstar Approach to Mutual Fund Analysis—Part I

DON PHILLIPS Managing Director, Corporate Strategy, Research, and Communications, and President, Fund Research, Morningstar, Inc.

 

PAUL D. KAPLAN, Ph.D., CFA Vice President, Quantitative Research, Morningstar, Inc.

CYCLE OF FEAR AND GREED

The mutual fund industry has done a remarkable job of creating scores of fine, reasonably priced funds that can meet almost any conceivable investment need. Unfortunately, however, good funds do not always translate into good results for investors. Even when using high-quality investment vehicles, such as low-cost, broad market index funds, investors too often buy high and sell low. The resulting damage from poorly timed buy and sell decisions can sabotage investors’ returns and represents what may well be considered the Achilles’ heel of investment management.

Both investors and fund companies share part of the blame for investors’ suboptimal use of the industry’s fund offerings. No one wins when investors are enticed to throw money at an overheated market or are tempted to pull out after a sharp correction, but little has been done to curb the practice. Fund companies do not run ads discouraging investors from buying their hottest funds, nor do they tout the recent losses of their most out-of-favor funds. Instead, the mutual fund marketing machine often amplifies the cycle of investors’ fear and greed—promoting aggressive funds at the market’s peak and more conservative offerings ...