9
Morningstar FundInvestor
June 2
014
The opposing results suggested by sector allocation
and stock selection fell right in line with our thesis
on the difficulty of market-timing and the relative
stability of stock-picking. We tried to combine the
two ideas by next asking: What if we had picked
the managers who ranked in the top half of the group
by stock-picking but the bottom half by sector allo-
cation? Doing so would eliminate managers who have
received a boost from sector-allocation decisions—a
source of excess return that has tended to be hard
to repeat. Instead, it would isolate those managers
and funds that have historically generated their
results via stock-picking alone. Using those criteria,
the results jumped to a
66%
success rate.
Figure
2
presents another dimension of the results
by showing the average excess returns that each
selected group delivered in the subsequent three-year
periods. Funds with peer-beating returns over the
past three years, for example, outpaced the index net-
of-fees by an average of
50
basis points three years
later. (The positive results are similar to the Morning-
star small-value category’s slight topping of the
index over the past decade.) Picking funds based on
allocation or stock-picking rankings resulted in some-
what worse or better outcomes, respectively, but
picking the funds that relied primarily on stock-picking
(funds that ranked in the top half of the group by
stock-picking results but the bottom half by sector-
allocation decisions) delivered a respectable average
annualized excess return of
119
basis points.
Screening the M500
Within the M
500
, five of the nine actively managed
small-value funds fell into the group that passed the
top-half stock-selection/bottom-half sector-allocation
screen, and we present them in Figure
3
.
Of the five funds, Chuck Myers of
Fidelity Small
Cap Value
FCPVX
(which is closed to new investors)
tends to keep his sector weightings close to his
benchmark’s, so by default, his source of added value
has had to come primarily from stock-picking. The
managers and teams at
Diamond Hill Small Cap
DHSCX
,
Perkins Small Cap Value
JSCVX
(closed),
AMG Managers Skyline Special Equities
SKSEX
,
and
Third Avenue Small Cap Value
TASCX
, in
contrast, frequently deviate from the Russell index’s
sector weightings; all of them more or less do so
based on where the most-attractive areas of the
market take their portfolios.
Finding the Stock-Pickers
If sector-allocation decisions tend to randomly affect
results (and, overall, even detract from returns),
then separating out the managers who have bene-
fited from those decisions essentially screens out
managers who have had luck on their side. It’s one
way to identify managers with strong returns who
have gotten there with a preponderance of luck from
those who have true, repeatable skill—the Warren
Buffetts. That’s not to say that luck can’t benefit
skillful managers as well, so this screen should be
considered as only one input among many when
selecting managers. But whether luck is fleeting or
not, it’s certainly hard to predict, which makes
focusing on stock-picking a promising alternative.
œ
Contact Janet Yang at
Figure 2
Added Value of Small-Value Funds
1.4
1.2
1.0
0.8
0.6
0.4
0.2
Return
Average excess returns versus Russell 2000 Value Index over rolling three-year
periods. Data from 04/2004 to 03/2014.
Sector
Allocation
Stock
Selection
Sector
and Stock
0.50
0.15
0.77
1.19
Figure 3
M500 Small-Value Funds
Fund
/ Ticker
Morningstar
Analyst
Rating
Avg 3-Yr Ann
Excess Returns
in Subsequent
3-Yr Period
Diamond Hill Small Cap
DHSCX
Œ
-1.4%
Fidelity Small Cap Value
FCPVX
•
1.4%
Perkins Small Cap Value
JSCVX
•
-3.2%
AMG Managers Skyline Special Eqts
SKSEX
´
6.5%
Third Avenue Sm Cap Value
TASCX
‰
-1.9%
