Monday, November 27, 2006

Morningstar Ratings performance

We launched the revised Morningstar Rating for funds in 2002, and each year since then we've updated a study on how the rating has performed. For background, the rating is a quantitative measure of risk-adjusted performance relative to a category over the past three-, five-, and 10-year periods.

Consistent with past studies, the new study shows that 5-star funds tend to outperform 4-star funds and so on. Thus, the biggest performance gap is from 5-star funds to 1-star funds. This was the case when measured by relative performance and the three-year star rating.

*** [9/5/17] ***

While the star rating has inherent limitations given its reliance on past performance, our analysis suggests that it can be a useful starting point for fund research. Indeed, the star rating appears to point investors toward cheaper funds that are easier to own and likelier to outperform in the future, qualities that correspond with investor success.


earnings growth to decline?

Earnings have increased at double-digit growth rates for almost five consecutive years--although many agree that earnings growth may be slowing, it's beyond almost everyone's foreseeable horizon that earnings might actually experience a decline.

Yet a look back at history provides insights about the earnings cycle and what is considered to be normal. Despite the statistics about average earnings growth, the business cycle drives periods of surge and stall. And the stall is generally a year or two of outright retreat, rather than smoothly slower growth. As reflected in Figure 1, earnings typically grow handsomely for three to five years, and then decline for a year or two before again growing. That's usually all that it takes to restore the balance.

Sunday, November 26, 2006

why fund managers don't beat the market

Have you ever wondered why the majority of active fund managers fall short of the market? After all, these professionals didn't get to be professionals by being bad investors.

A study done by finance professors Gordon J. Alexander, Gjergji Cici, and Scott Gibson sheds some light on the subject. The study shows that one reason active fund managers have trouble beating the market is their funds' liquidity policies.

Friday, November 17, 2006

Trading Systems (technical analysis)

There are many different systems and techniques that traders can learn to help themselves gain an edge in their trading. Some of these are complex, but they do not have to be complex to be good. The 10-day System is probably the simplest one you will ever learn, yet it can be very helpful, especially during choppy markets.

Wednesday, November 15, 2006

Investor Returns

We've all heard horror stories that illustrate investors' tendency to buy high and sell low. But just how bad is investors' timing, really? To answer that question, we took a look at investor returns, also known as asset-weighted returns, which Morningstar recently began calculating for funds in its database.

By factoring in the timing of investors' purchases and sales, investor returns depict the returns earned by the typical investor. In aggregate, the data show that investor returns have generally lagged those of funds' published total returns, which assume a buy-and-hold strategy.

Are the anecdotes about investors' poor timing overblown, based on Morningstar investor returns? No. Although most fund categories' total returns and investor returns were fairly close to one another over the past three- and five-year periods, the gap between the two widened substantially over the trailing 10-year period. That's likely because the 10-year period encompassed the late 1990s' bull run as well as the bear market, and both extremes tended to stimulate poor decision-making.

[10/13/09] CGM Focus (CGMFX) and T. Rowe Price Equity Income (PRFDX) illustrate how volatility affects investor behavior. Both are run by excellent managers (Ken Heebner and Brian Rogers, respectively) who have beaten their peers over the long term. Focus' 10-year annualized return of 19.6% thumps Equity Income's 3.7% yearly return through the end of September 2009--as it should, because Heebner takes much bigger risks than Rogers. Heebner makes huge sector bets, holds only about 20 stocks, and even sells short stocks that he thinks are primed for a fall. Rogers aims for a steady ride by focusing on reasonably priced, dividend-paying stocks.

But consider what investors actually earned. Rogers' clients have kept nearly all of the fund's meager gains, earning an average of 3% annualized over the past 10 years. Heebner's have somehow turned their fund's terrific reported results into an annualized loss of 14%. They managed that feat by piling into CGM Focus after its extraordinary 80% gain in 2007, only to get pummeled when Focus plunged 48% in 2008.

[7/27/12] Among the most interesting data points available on Morningstar.com is investor returns, which reflects actual investor experience with a fund as opposed to how the fund itself performed in isolation.

A fund's total return depicts whatever returns its basket of securities earned from one given point in time to another. But not every investor was on board the fund for the whole time period, and that's what investor returns attempts to capture. We calculate investor returns by using fund inflow and outflow data and applying it to fund performance. We can then see how the average investor fared relative to the fund.

To illustrate how total and investor returns can differ, consider a fund that gains 12% in the first three months of the year, then remains flat for the remainder. Its gain for the entire year is 12%. But what about the investor who, seeing the fund's hot early performance, jumps in during month number four? His or her return for the year is zero. As you can see, the difference between investor return and a fund's total return can be quite dramatic.

Two common themes that emerge here are investors piling into funds with excellent track records that are unable to repeat those strong performances, and investors abandoning funds after sharp downturns and thus missing out on the subsequent rebound.

Monday, November 13, 2006

A Baseball Story

David Gardner was a batboy, Ron Washington an unspectacular weak-hitting middle infielder.

Tuesday, November 07, 2006

Democratic victory could lead to stock selloff

NEW YORK (CNNMoney.com) -- With strong earnings, lower oil prices and a slowing economy to focus on, stock investors haven't exactly been paying attention to Tuesday's congressional elections. But maybe they should be.

Various reports indicate the Republicans are in danger of losing 20 to 35 seats - and their majority - in the House. In the Senate, the GOP is expected to lose at least four seats, in which case they would still be in control, or as many as six, which would swing the Senate to the Democrats.

Either scenario would mean the president and the Congress will no longer be controlled by the same party, aka gridlock. And for stocks, that's a mixed bag.

In the short term, a change in control of at least one of the chambers of Congress would probably spark a stock selloff, investors and market experts said. That's because traditionally Republican Wall Street would seem to prefer to have Republicans in control of Capitol Hill as well as the White House since the party's policies are widely viewed as more big business friendly.

Should the Republicans hold on to both chambers of Congress, "we can anticipate an upward - though likely short-lived - trend" in the market, said David Leblang, a political science professor at the University of Colorado, Boulder.

But in the long term, having either party in full control is not necessarily a good thing. In fact, in the long term, "the market actually likes the executive and legislative branches under different leadership as it reduces any damage coming out of Washington," said John Davidson, president of money manager PartnerRe Asset Management.

That was certainly the case in the 1990s when the pairing of Democrat Bill Clinton in the White House and a Republican-controlled Congress coincided with the longest economic expansion in the history of the United States - the famed tech-driven 90's boom.

A recent Ned Davis Research study suggests the market could weaken between the elections and the end of the year, if the last 104 years are any guide.

That's because 2006 is a mid-term year for a second-term president. In such years, a change in one or both houses of Congress has usually coincided with the Dow gaining in the months leading up to the election, and then sputtering or sliding through the end of the year.

* * *

[S&P's Sam Stovall offers a slightly different viewpoint.]

The mid-term elections are upon us. Control of the Senate and House of Representatives is up for grabs. Even though the Democrats may take control of the House, the odds are long for a total sweep. But as Harry Truman proved in 1948, anything is possible.

Currently, the Republicans control both the executive and legislative branches of the U.S. government. So the obvious question is: What happened to stock prices when one party surrendered partial or total control of Congress? This scenario has occurred six times since 1945 — twice to Democratic presidents and four times to Republican chief executives. Interestingly, Wall Street responded favorably to the change, with the S&P 500 posting an average price advance of 4.8% during November and December of those years (five of the six times, the S&P 500 had a gain for the year). Remember, however, that what worked in the past may not work again in the future.

So, what can investors expect in 2007?

Next year marks the third year of President Bush's second term in office. Historically, stock prices have posted their best performances in the third year of the presidential cycle, rising an average of 18% since 1945 vs. an average of 9% for all four years. What's more, third-year advances have been very consistent, as the S&P 500 climbed 93% of the time (the market was flat in 1947). The last time the "500" declined in the third year was 1939. The fourth year's 8.6% average increase is second highest.

* * *

[11/8/06 Tomorrow's News Today] The U.S. stock market had a solid rally in October and now the major indices might be due for a pause, some technical analysts say.

Merger and acquisition news and solid third-quarter earnings have pushed stocks sharply higher over the last few days.

On Tuesday, the Nasdaq Composite index finished at 2376, roughly three points below its recent five-and-a-half year closing high, hit on Oct. 26. The broad Standard & Poor’s 500 index ended at 1383, only six points lower than its six-year closing high.

Both indices are now looking a little overextended, based on weekly stochastics that measure of how overbought or oversold stocks are, said Katie Townshend, chief market technician at MKM Partners.

Their uptrend off their summertime lows is much too steep to appear sustainable, she said.

Already momentum is beginning to slow in sectors like utitities and real estate investment trusts, she said.

Sunday, November 05, 2006

A Great Company Can Be a Great Investment

Gary Smith, an economics professor at California's Pomona College, thinks as many informed investors do that despite its triumphs now probably isn't the best time to buy shares of Genius Corp. Why? As Smith himself teaches his students, a great company doesn't necessarily make a great stock. By the time a company and its CEO are touted on the cover of a magazine, everyone already knows about them and how wonderful they are. Their virtues are already factored into the share price, leaving it nowhere to go but down. This is known as the efficient market hypothesis.

That's what makes the results of a study co-authored by Smith called "A Great Company Can Be a Great Investment" all the more surprising. The Pomona professor found that contrary to the efficient market hypothesis certain popular companies that have become household names tend to outperform the broad market.

Smith put together portfolios based on Fortune magazine's annual list of the 10 most-admired companies in the U.S. For the study, Smith took the top-10 companies from 1983 to 2004 and compared those returns with the S&P 500 index's returns. He found that the Fortune portfolio, which usually consisted of big-name blue chips like General Electric (GE), Dell (DELL), Berkshire Hathaway (BRK.A), Starbucks (SBUX) and Microsoft (MSFT), outperformed the S&P 500 by an average of six percentage points during the year following the publication of the list.

The results, Smith says, didn't jibe with his typically contrarian investing outlook. "There may be something to buying stock in great companies, which I never believed before," he says.

[via Russ@value_investment_thoughts]

Friday, November 03, 2006

Are growth funds poised to outperform value?

Morningstar shows that growth funds look a lot more like value funds than they did in March 2000.

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Is it time for value to hand the baton to growth? The contrarian in us wants to say yes. Morningstar's large-cap growth category has lagged every domestic diversified stock fund group more often than not during the past six years. Based on performance and the idea that value won't trample on growth indefinitely, it seems reasonable to conclude that large-cap growth funds are ripe for their turn at the head of the pack.

Hold on, though, while we examine a few crucial facts. Large-cap growth funds may indeed be due for a comeback, but as a group they are not screaming buys, according to underlying fundamentals. In fact, large-cap growth funds don't look drastically different from large-cap value funds in some regards.