Every year Russel Kinnel, director of manager research for Morningstar, attempts to find what he defines as “fantastic funds,” easily screening down the entire realm from 8,000-plus options to a few dozen.
Every investor wishes they had a “terrific” portfolio of mutual funds.
You can have exactly that without having all your funds be “terrific.”
For proof, consider the latest research effort from Russel Kinnel, director of manager research for Morningstar, who at the start of September published his latest effort to pick the top funds in the business, but whose own actions as a fund investor help prove why top funds on a performance chart are less important than solid, stalwart funds in your personal accounts.
Every year Kinnel attempts to find what he defines as “fantastic funds,” easily screening down the entire realm from 8,000-plus options to a few dozen. This year, 28 funds passed Kinnel’s tests, which are purely quantitative.
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He’s not picking his favorites — in fact, Kinnel admits that there are many funds he likes, owns and admires that are not on the list — but instead follows a quantitative approach to determine a list of funds that inspire admiration, trust and confidence.
Kinnel’s list is important in the fund world because it’s not the typical “best funds” list put together by personal-finance magazines and websites. Those subjective rankings typically are incomplete, flawed and more hurtful than helpful for do-it-yourself investors.
It’s a jumping-off point for investors looking to own funds that are only flashy when looked at from a long view, but it also highlights the factors that help to separate good funds from the pack.
Kinnel looked at costs (funds must be in the cheapest quintile of their broad category group), manager investment in the fund ($1 million or more), returns above the fund’s benchmark throughout the tenure of the current manager (meaning the fund has not lagged its target in any year the lead manager has been at the helm, a minimum of five years), and then layered in Morningstar risk ratings (below high), Morningstar medalist status (bronze or higher), and more.
The 28 funds that made the cut are a Who’s Who of top names, which is not a surprise given the criteria.
While they do tend to be concentrated from a few large fund companies — a side effect of the cost criteria, because small fund firms often lack the economies-of-scale to keep costs at the very bottom of their categories — the group represents a good-idea listing for anyone looking to diversify or expand their holdings.
The 28 are not, however, a portfolio, nor are they some sort of “must-own” for investors anxious to reach their goals.
(That’s also why I am not listing the funds here: to see the list go to https://www.morningstar.com/articles/881522/28-terrific-funds.html)
For starters, Kinnel’s methodology excluded index funds — a low-cost portfolio cornerstone for millions of happy investors — because they’re built to match a benchmark, not to exceed it.
Next, Kinnel was looking for “terrific funds” without any regard to their category, and some areas — like municipal bonds, emerging markets and more — had no funds that made the cut.
It’s hard to build a strong portfolio if it has major holes in it.
Then there were the categories that had several representatives; from a portfolio-building perspective, there have been many widely accepted studies showing that having several similar funds in a portfolio dilutes the unique performance characteristics of the winners and produces lesser results.
Thus, owning all three of the large-cap value funds to make the Terrific 28 would be a bad idea; instead of getting “terrific” results, the three funds would likely combine to produce average or index-level results for the large-value portion of your investments.
But Kinnel himself is living proof that investors benefit from owning good funds and sticking to plans, rather than constantly trying to buy “better” funds that are only marginally better.
In his personal portfolio, Kinnel owns 20 funds across his 401(k), individual retirement and taxable accounts.
Five of his holdings made the list he published in September.
He’s not changing or “upgrading” his portfolio based on any of the research that went into the terrific list.
“Nothing really jumped out at me [from the list] as something I want to own because I already am happy with what I own and, in general, I have been rewarded for being a patient investor,” Kinnel said in an interview.
Kinnel noted that as he has gotten older and his portfolio has grown in value, he has also appreciated that “you don’t need more funds and you value simplification … particularly if it helps you stick with your plan for reaching a certain target.”
Sticking with a plan — rather than chasing the perceived best funds of the moment — is what had investors buying equities in 2009 and bonds in 2017, Kinnel noted, and moves like that are more critical to long-term investment success than chasing after the very top performers.
Ultimately, while investors can use Kinnel’s list as a jumping-off point, they most likely should use his methodology as a first step, deciding what hurdles they want the funds they own to clear (like below-average costs, consistent performance within their peer group, and superior long-term results, etc.), and then applying that criteria to unemotionally come up with their own list of potential buys.
“There’s an endless amount of data on funds,” Kinnel said, noting that investors can cut through the data by deciding the characteristics they most value in a fund.
Doing that, they can come up with a personalized list. “Use the most important data points, get really picky and set a really high standard for each one of those and see what falls out,” he said.
Build a portfolio with funds that meet your criteria and that you can live with and you are likely to be an investor who gets terrific results over time.
You almost certainly will not own all of the best funds, but that’s fine so long as they are the right funds for you.