By Penny Marchand, CFP®, EA
Tucson, AZ
http://www.cambridgefinancialgroup.com/
With more than 9,000 mutual funds and almost 1,000 exchange-traded funds (ETFs) in the United States, wading through so many investment choices can be daunting. Do you ever wonder how your ACA advisor does it?
The Suggested Funds List helps many advisors streamline the investment decision process. The list (formerly called the Directed Portfolio) includes suggestions for both actively managed funds and passive index funds, ETFs, and Dimensional Fund Advisors (DFA) funds.
To improve the selection and ongoing evaluation of actively managed funds, the ACA investment team uses a patented process developed by Klein Decisions. This process evaluates mutual funds using an objective analysis that considers several different criteria:
Expense Ratio: Expresses the percentage of a fund’s assets used to pay for operating expenses. The lower the expense ratio, the better.
3-year Morningstar Rating and 3-year Morningstar Risk: Measures both the historical performance of a fund compared to its peers and the fund’s volatility. The higher the rating and the lower the risk, the better.
Fiduciary Score: Rates a mutual fund analytically with a pass/fail score based on acceptable fiduciary requirements, such as how long the fund has been in existence, manager tenure, fund assets, composition, style drift, expense ratio, alpha, Sharpe ratio, and performance relative to its peers. A fiduciary score of 0 is most favorable.
Rolling Return ± Category Index 1 in 5 years: Looks at each 1-year period within 5 years and averages the amount (in percentage points) by which the fund has outperformed or underperformed the category index. The higher the rolling return, the better.
Rolling Batting Average 3 in 5 years: Measures the fund’s consistency. For example, a fund that equals or outperforms the index each month in a given period would have a batting average of 100. A fund that beats the index 50% of the time would have a score of 50. The higher the rolling batting average, the better.
Rolling Information Ratio 3 in 5 years: Calculates risk-adjusted performance. It’s similar to a common measure of volatility called the Sharpe ratio, except it measures risk to a specific benchmark index most appropriate for the fund being evaluated. The higher the rolling information ratio, the better.
Duration (for bond funds only): Measures how much the fund’s value will be affected by changes in interest rates. The higher the duration, the more it will be affected by rising or falling rates.
Average Credit Quality (for bond funds only): Describes how likely the fund’s bond issuers are to
default on their payments. The higher the credit quality, the less likely it is that the fund will experience a default.
Klein’s software then assigns the funds points and ranks them. For instance, if a fund has a low expense ratio, it will get more points than a fund with a high expense ratio. If a fund has consistent returns over a 5-year period, it will score higher than a fund that has had one or two good years.
This is how the ACA investment team identifies the top 25 funds listed in each asset class. The team then screens for several other characteristics before making its final selections:
• Manager Tenure
• Brokerage availability
• Investment minimums
• Whether the fund is open or closed to new investors
• Overall suitability for clients of ACA members
The team also looks closely at funds that were previously selected but no longer appear on the top 25 list. They may choose to keep them on the Suggested Funds List with a note to ACA members, or remove them from the list altogether.
Considerable time was spent designing the final selection criteria. These characteristics help the investment team identify our top-ranked funds. The team uses a weighted scoring system, based on the selection criteria just described.
Many ACA members use their own criteria for selecting mutual funds, either as a completely separate process or in conjunction with the Selected Funds List. The list is a tool that preselects some of the best mutual funds available, leaving your advisor more time to focus on your unique
financial needs.
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