| How March Madness can help to guide investment choices
I was talking with a fund manager last week, when the conversation turned to sports, and how March Madness has gripped his office.
The basketball phenomenon of March Madness - starting with conference tournaments, leading to the NCAA tournament and finishing with the crowning of a national champion - is an obsession for a lot of sports junkies. The manager being one of them, he started breaking down which teams should make the "Big Dance" (taking particular delight in reasons why my alma mater should not go).
The more he talked, the more it became clear that the same elements that put a team into the tournament are involved in putting a mutual fund in an investor's portfolio.
The result is a bit different - you're trying to "set the field" for your portfolio rather than crown a champ - but the factors under analysis are the same.
With that in mind, here's something for basketball fans and fund owners to try during the lulls in March Madness: See if your holdings have earned a spot in your field. When you find a fund that is "on the bubble" - meaning it's not an obvious choice to buy again today - you'll have a "watch list" of funds that may, in time, deserve the boot.
Here are the factors that get a school into the Big Dance, and that should factor into a fund making your portfolio:
• The conference they play in: In hoops, there are "power conferences" - where a sixth-place team might make the tournament - and "mid-major conferences," where only the tournament champion goes. In mutual funds, there are asset classes.
Your search for a fund should start by deciding the type of assets you want to own. If you want a large-cap growth fund, you've got a huge category with a lot of "teams" worthy of consideration. If you want a small-cap value fund, there may be few top options open to new investors.
In smaller asset classes, you'll only want to pick your version of the "conference champ." In the bigger categories, you may opt to diversify into two or three funds. Keep in mind, however, that research shows that any four funds from the same group tend to create a "closet index fund," where you pay the expenses for active management but wind up with performance that matches the index."
As you build your portfolio, however, you want to have funds from different asset classes. If you invest in five funds from the very same league, you're not as diversified as you think.
• Conference record: In basketball, it's important to be in the top half of your league. In mutual funds, it's about being consistently in the top half of the fund's peer group and being in the top one-third over longer time periods.
A fund is allowed a bad year, just like a basketball team is allowed a bad game. But you want to see how it bounces back, and the peer group comparison is key in deciding if the fund is good enough, or if you might want to side with the competition.
• Quality wins: This is the NCAA's way of saying that you beat good opponents, and a mutual fund's way of showing that it performed well in tough times.
If a fund only does well when everything is working in it's favor, it may just be riding the tide. If it can give you most or all of the market's upside while protecting you a bit when things are down, it's showing that it may belong.
• Strength of schedule: In basketball, you want to play tough opponents, rather than cupcakes. In mutual funds, it's not a bad idea to favor a fund that has results over a lot of time periods, so that you can judge it based on everything from the last quarter to the last decade or more.
• Power rankings: In basketball, this is the computer's attempt to suggest that one team is better than another; in mutual funds, it's star ratings, numerical rankings and more.
Morningstar's five-star system, for example, is a risk-reward calculation designed to say if the fund delivered a reasonable return for the amount of risk it took. Lipper Inc., meanwhile, breaks fund performance down into five categories (total return, consistent return, preservation of capital, expenses and tax-efficiency) and gives number grades in each.
[More at www.baltimoresun.com ]
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