Markets were higher today on upbeat earnings and manufacturing data. The S&P 500 closed at an all time high and is now up 0.07 percent for the year! Who knew such a little return could be so exciting.
Much of the excitement about earnings came from Bank of America (BAC), which posted its highest annual profit since the financial crisis. Back in 2007, when BAC had a market capitalization of $183.2 billion, it earned $14.9 billion, which means that the price-earnings ratio was 12.3.
Today, the market capitalization is basically back to the same level at $182.9 (it had been as high as $214.0 billion) and earned $11.4 billion, for a price-earnings ratio of 16.0.
I have a love-hate relationship with Morningstar. They provide a lot of terrific, useful data for next to nothing and I go to their website every single day – literally. Hate is a strong word, I suppose, but they do frustrate me.
In November, I wrote about the confusing nature of their multiple ratings systems, that we understand (but don’t use) that are frequently misunderstood by clients.
Today, I am a little annoyed because they are making a big splash, announcing their 2013 Fund Managers of the Year.
This year, they have five categories: domestic stock, international stock, bond, asset allocation and alternatives.
According to Morningstar, the award isn’t just for great performance in the single year and the fund managers must have other attributes including good ratings by Morningstar analysts, attractive long-term risk adjusted returns and be good stewards of investor capital.
Morningstar explicitly writes that, ‘while our awards are recognition of past contributions rather than predictions of future results, we’re confident in each one’s long-term prospects…’
This statement is akin to the ‘past performance is not indicative of future performance,’ but the implication is clear: these guys can manage money and you should invest with them. That’s what I read anyway. And I’ll bet that the winning mutual funds put ‘Morningstar Manager of the Year’ in their marketing materials.
So, should investors put their money with the managers of the year?
I looked back at the 2005 Manager of the Year, Chris Davis of the New York Venture fund. I only have 10 years of data when I’m at home (I write a lot at night) because that’s as far back as the data goes on Morningstar’s website (see – it’s great data!).
By looking at the 2005 winner, I can see the results for the three-years prior to the win, the results the year of the win and the subsequent returns.
For Chris Davis’ New York Venture fund, 2005 was an excellent year, they were up 10.68 percent versus 4.91 percent for the S&P 500, their stated benchmark. That year, they also beat 93 percent of their peers.
For the three-years that ended in 2005, the New York Venture fund smoked the market, gaining 18.07 percent per year compared to 14.39 percent for the market.
With these results and the accolades from Morningstar, I’ll bet investors were pouring money into the fund.
How did those new investors fare? Over the next three years, the fund lost 10.18 percent per year – it did include 2008, which was bad for everyone. But not as bad, I suppose, since the S&P 500 lost -8.36 percent per year over the same time frame.
The investors who had been with Chris Davis for the three years prior to the award were still marginally ahead of the market, 2.98 percent per year versus 2.38 percent.
What if the investors who bought based on the award hung on through today? They would be up 5.63 percent, substantially below the S&P 500, which gained 7.08 percent.
What about the original investors, who were in for the full 10 years? They earned 8.89 percent, a great return, just under the S&Ps 9.02 percent.
If you think I’m picking on Chris Davis, I’m not. I did the same analysis for Longleaf Partners, Fidelity Contrafund, Royce Special Equity Investments, Fairhomle fund and found basically the same results to varying degrees.
I will say that this is a casual look on my part. To really test this, I would need to look at all of the previous winners in all categories. I would also need to see if the results were due to simple size and value tilts and what could be attributed to alpha, the technical term for manager skill.
My bet is that the Morningstar’s Manaer of the Year is a bit like Time Magazine’s Person of the year – not always so great. Mahatma Gandhi in 1930 was good, but what about Joseph Stalin in 1939 and 1942, or Richard Nixon in 1971 and 1972? (Although I’m not Catholic, I think Pope Francis is a fantastic choice this year – much more so than Edward Snowden).
Awards like Manager of the Year emphasize short-term performance chasing and despite Morningstar’s disclaimer, inventors suffer for it.