Morningstar Ratings and management fees

[scp]

Is it safe to say that I'm better off investing in mutual funds that have Morningstar ratings of 4/5 stars and management fees of less than1.5% than funds with lower ratings and higher management fees?

Or are Morningstar ratings just as bad as looking at historical performance?

What are other factors you look at when deciding on a mutual fund (ie Sharpe ratio, historical performance, turnover rate) and what order of emphasis would you place on them?

And does anyone know how to look up previously closed/ desired mutual funds that are now open?

[Broken Arrow]

Not everyone will agree with me, but this is my take on it:

The MorningStar ratings are based on how well it performs relative to the performance of similar funds in the industry. So, if a fund is out-performing the industry average of competing funds, it receives a higher star rating.

I do think some people place too much value into the ratings. It's not useless or anything, and I look at it too. However, just because it's out-performing the average right now doesn't necessarily mean it will continue to do so into the future.

To get a better idea, I typically look at the fund managers who are involved. For example, you really don't want someone who just graduated with no experience managing your core funds if you can help it. Then, I look at the historical performance based on their tenure, overlayed with the S&P 500. That gives you a quick idea of how well the fund has performed under them. With some exceptions, I think you'll find that most funds don't actually fluctuate that much from its respective index....

I also read up on all the prospectuses of the funds I am interested in buying. However, certain details that may be of interest (such as certain transactions and holdings) may not be available on the prospectus, and you have to contact your firm to obtain those additional information.

Last but certainly not the least, I also look at the loads and fees. Even if you have a good manager and a good fund, if the fund itself is too expensive to invest, it'll still water down your return. All things being equal, it's best to buy the least expensive funds.

And yes, I look at all the technical stats that you've mentioned as well, especially if it's actively managed funds. For example, if the turnover rate is low or if it's an index fund, then I wouldn't place as much emphasis on the manager. I don't put any emphasis on historical performance short of what was mentioned above....

Yahoo Finance and Google Finance can look up mutual funds and give you the basic stats. MorningStar also has a nice fund screener that will work too.

[kork13]

scp, good question... I've actually wondered about everyone's thoughts on MF selection "strategies" (bad way to describe it) as well... Basically just how you go about separating the good from the questionable. A big question for me, that you did highlight... what is considered "low", "average", and "high" for management fees/expense ratios?

About morningstar, they are fairly respected in quantifying a MF's performance in a simple, unbiased way. But really, they probably aren't much better than past performance. However, it is still important to consider past performance, especially if the MF has had largely the same management team over the last 5-10 years, because you can conclude that if their investment style/strategies have been effective in the past, they may (reiterate: MAY) be better at using effective strategies in the future.

[jIM_Ohio]

The biggest fee to look at is what you pay to make the investment. These are often referred to as loads or sales charges. I avoid these fees like the plague.

The management fees are used by many people as a screening criteria for funds, but the management fee is no better predictor of future performance than morning star rating, beta, alpha or other metric.

Assuming an investor knows their allocation, and has chosen a broker, choosing the funds is EASY part. Plug and play if you will.

I agree with BA that most large cap funds will track to the index without much research.

Your issue should be does fund follow index all the way down or all the way up? If it drops more, understand the risks it takes and verify it goes up more than index too.

I use the reverse- I make sure my funds do not drop as far as the index, so when the index goes up, I expect to lag it some.

Large cap funds should be tracked to S&P 500, even if the fund does not own all 500 stocks in the index. If you are looking at only using index funds, I am finding it as difficult these days to sort through index funds as I am managed funds.

Vanguard has around 8-10 large cap index funds. There is the S&P 500, a value index, a dividend index, a dividend increasing index, a growth index and similar. Before choosing something like this, make sure you know how the index is created.

[Broken Arrow]

Yes, thank you for pointing that out Jim. I was thinking large caps when I wrote that, but it's certainly not the only type of fund out there, and the S&P500 isn't always the most appropriate index to measure all of your funds.

[jIM_Ohio]

Yes, thank you for pointing that out Jim. I was thinking large caps when I wrote that, but it's certainly not the only type of fund out there, and the S&P500 isn't always the most appropriate index to measure all of your funds.

I was not suggesting to not use the S&P 500 as a proxy index for other asset classes, but I was pointing out that for a large cap fund, it appears there are new indexes popping up all over the place, and funds popping up to invest in those indexes.

ALWAYS measure a fund's performance vs the S&P 500 is my opinion. The S&P 500 represents 75% of the market's performance. If you find a fund which does not correlate well, you found the other 25%.

The big thing you will see is the dips in one will be the dips in the other, just one may not dip as deep. The spikes in one will be the spikes in the other, one spike might be higher though. The noise in between is where you look for the differences and is where diversification and deviation from the index is important.

Example-

I own PRFDX T Rowe Equity Income
My only benchmark for this is the S&P 500.
Both are large cap indexes

I own PRDSX T Rowe Diversified Small Cap
My benchmarks for this will be S&P 500 and probably Russell 2000 index.
When the S&P dropped last week I am sure my fund dropped, even though the fund owns maybe 1-2 stocks in that index. I will look what my fund did when the SP spiked and when the S&P dropped- both should match. What will not match is what happens between the peaks and valleys and that is where diversification improves returns and reduces risks.

I will then also do the same for the Russell 2000 which is a common mid and small cap index.

[feh]

I refuse to buy any fund that has a management fee over 1%. And I only buy no-load funds.

And as I'm sure you've read, it's not easy to beat an index fund, which would have a miniscule management fee.

[KGeary]

I wouldn't buy funds with more than 1% either and with no load.

The best funds out there, historically, are index funds. Not only do the perform with or outperform the market, they are cheap cheap cheap, which translates to more in your pocket. Over the long run, you'd be surprised to see the difference in your portfolio value with lower expense ratio funds than higher. The expense ratio is one of the most important factors.

[atomicrc11]

I take expense ratio quite seriously, most of my money is in Spartan Index Funds from Fidelity which have a 0.10% expense ratio. Where I tend to go high on the expense ratio is Small Cap stocks, Bonds, and Specialty funds.

Small Cap stocks usually are higher just because of the area of the market. Bonds are a little higher than most indicies simply because there is more effort in trading them.

Then Specialty funds depends on what they are doing, but some are higher. One I like is Fidelity Leveraged Company Stock Fund. It has a 0.83% expense ratio, but when compared to the S&P 500 over the last 10 years it is up 60% while the S&P 500 index is down 31%. It just so happens that when I started working I put money into this fund and it has paid off. High return, but certainly much higher risk.

Don't let an expense ratio put you off. Expense ratio's are only part of the considerations and if the fund fits into your portfolio, buy it. You'd be missing out on a lot of good funds just looking at expense ratio.

[feh]

Then Specialty funds depends on what they are doing, but some are higher. One I like is Fidelity Leveraged Company Stock Fund. It has a 0.83% expense ratio, but when compared to the S&P 500 over the last 10 years it is up 60% while the S&P 500 index is down 31%. It just so happens that when I started working I put money into this fund and it has paid off. High return, but certainly much higher risk.

We have quite a bit invested in FLVCX also. Seems to be an excellent fund, as long as you can tolerate the risk (drops more than the index in bad times, rises faster than the index in good).