8
Morningstar analysts often turn to attribution results
when digging into a manager’s performance. The
analysis typically compares a strategy’s returns with
an index, dividing results between the portion of
outperformance attributable to a manager’s sector-
allocation decisions and the portion that comes
from stock-picking results.While the former can often
have a big effect on returns—avoiding financials
stocks in
2008
has become a go-to example of this—
there’s much academic and industry research that
suggests it is very difficult to consistently make win-
ning market-timing calls.
Morningstar’s collective decades of experience
analyzing performance suggest that manager’s stock-
picking skills tend to have a degree of stability and
persistence, though, and we wondered if there was a
way to apply the essentially ex-post examination of
a manager’s attribution results into an ex-ante method
of finding future outperformers. Our research is still
in its early stages, but the results so far have
been promising.
To look into the question, we expanded our analysis of
attribution results from its usual manager-by-manager
examination into a wider one that compared each
fund’s attribution results with its peers’. We limited
the analysis to the
10
years between April
1
,
2004
,
and March
31
,
2014
, and looked only at the small-cap
value universe. Smaller-cap stocks have generally
outpaced their larger-cap counterparts over the past
decade, while value- and growth-style small-cap
funds have both roughly evenly outpaced those in the
blend bucket. Choosing the small-value corner of the
Morningstar Style Box, then, helped to prevent the
results from being skewed by managers’ “cheating”
via market-cap or investment-style deviations. We
also made sure to include all distinct funds that exist-
ed throughout the
10
-year period, as survivorship bias
would otherwise likely positively skew the results.
We then took three-year rolling results and essentially
tried to answer this question: If we were to pick
funds that ranked in the top half of the group based on
the past three years of returns, allocation effects, or
stock-picking results, what would be the chance that
those funds would outpace the Russell
2000
Value
Index three years later? Figure
1
displays the average
success rates of all of those rolling three-year results.
Funds ranking in the top half of the small-value peer
group based on the past three years of returns,
on average, had a
50%
chance of outperforming the
index three years later; so at least in this case, past
returns provided little to no help in picking funds
that would do well in the future. Choosing funds with
the strongest past sector-allocation effects seemed
to actually provide negative information: Those with
the strongest showing on that front, on average,
ended up outpacing the index less than half the time
three years hence. This goes back to the point
about how difficult it is to make good sector bets. It
also speaks to the fact that sectors rotate in and
out of favor, so a fund that favors a couple of sectors
will naturally have ups and downs that likely even
out over time.
Picking funds based on stock-picking skill, however,
appeared to hold some promise. On average,
managers that ranked in the top half of the small-
value category based on three-year rolling
stock-picking attribution later went on to beat the
benchmark three years later
55%
of the time.
Buy the Stock-Pickers and Avoid the
Sector-Pickers
Morningstar Research
|
Janet Yang
Figure 1
Success Rates for Small-Value Funds
100
75
50
25
Return
Percentage of funds that outpaced the Russell 2000 Value Index over rolling
three-year periods. Data from 04/2004 to 03/2014.
Sector
Allocation
Stock
Selection
Sector
and Stock
50
%
47
%
55
%
66
%
