Check Your Mutual Fund's Score

Many of us are accustomed to reviewing specific criteria when selecting mutual funds for our portfolios. We commonly review things such as performance, volatility, asset class style, correlation to a benchmark index or peer group, expense ratio, top 10 holdings, etc.

These might best be referred to as "quantitative" factors and are obviously as helpful as historical data can be. But shouldn't we pay as much attention to the "qualitative" factors as well?

I'm referring to characteristics of the mutual fund and its management team that indicate the overall attitude toward their investors and the degree of stewardship expressed through their actions.

This is becoming such a hot topic that the most recognized mutual fund rating service, Morningstar, has created its own "Stewardship Grade" and is attempting to apply it to all of the mutual funds in its rating universe. This new measurement was introduced last October with an initial list of 500 funds and assigns a rating from A (best) to F (worst) based on how a mutual fund scores in five key areas: regulatory issues, board quality, manager incentives, expenses and overall corporate culture.

For example, Morningstar commentary might include remarks about the following: Whether or not the mutual fund has run afoul of regulators in the past three years; How diligent the board is in controlling expenses; If the firm has a history of launching lousy funds; If there are conflicts of interest at the board level; If the manager's pay structure provides an incentive to act prudently or conversely, too aggressively; If the firm passes on economies of scale to its investors as the fund grows in size; and Whether or not the firm has a thorough understanding of its role as a fiduciary.

I've reviewed several of these reports in the past year and find the commentary to be very helpful and insightful. These ratings should not be looked at in isolation or as the only factor to consider when making an investment decision, but they certainly can provide a confirmation to other research prior to buying or selling shares.

Another service that I find very useful is the Mutual Fund Analyzer, which was created by the Center for Fiduciary Studies and is available to financial advisers by subscription. This tool is more quantitative than the Morningstar commentary, but uses Morningstar statistical information. The screens then are built on proprietary fiduciary due diligence data and rate factors such as: Minimum track record of fund management; Assets under management; Stability of organization; Consistency of holdings with stated management style; Correlation of style with peer group; Expense ratio; Performance relative to assumed risk; and Performance relative to peer group.

The Center for Fiduciary Studies has some guidelines regarding the appropriate parameters to set when screening for suitable funds, but ultimately leaves the decision up to the adviser. This can be a very useful tool when trying to narrow the large universe of funds to something more suitable for portfolio construction.

So, how many mutual funds achieved passing or acceptable scores in the latest review (quarter ending June 30) by the Center for Fiduciary Studies? Out of 16,303 funds rated, 1,689 funds, or 10.36 percent, received an acceptable score.

These new tools, while not perfect, attempt to offer some insight into the intangibles that may affect your overall portfolio performance. I'm glad to see these resources made available to investment professionals and private investors, and the mere fact that they exist should serve to focus the attention of fund managers and boards on the issue of stewardship and fiduciary responsibility.