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Has asset growth altered your fund’s strategy?
Has it done so to the point where it starts to
hurt performance?
These are the questions that the bloat ratio aims to
answer. The bloat ratio is a figure I came up with
years ago to dig into issues of liquidity and trading
costs. The raw ingredients for bloat ratio are the
fund’s turnover ratio, the fund’s top
25
holdings and
the number of shares it holds, and the average daily
trading volume for those holdings. First, divide the
average daily trading volume by the number of shares
owned by the fund. That tells us how many days’
trading volume the fund owns. The bigger the number,
the less liquid the position. If a fund owns, say,
10
days’ trading volume of a stock, it might take months
to get out without crushing the price. Then, we take
the average of the fund’s trading volume figures and
multiply by the turnover ratio. (That
10
days’ trading
volume position might be manageable for a fund with
10%
turnover, but the trading costs will likely be
steep for one with
100%
turnover.) That gives us the
bloat ratio.
It has merit both for descriptive and predictive power.
It helps you understand the fund’s bloat relative
to peers. In addition, changes in the bloat ratio can
signal changes in strategy, including those brought
on by asset bloat.
In order to test predictive power, I grouped funds by
their bloat ratio and then tracked returns over the
ensuing five years. I looked within large-cap U.S. funds,
mid-cap U.S. funds, and small-cap U.S. funds.
I backed out expense ratios for the test in order to
isolate bloat. One positive effect of asset growth
is that expense ratios usually fall, so I wanted to keep
that out of the equation. I also excluded funds
under
$100
million, as they are less likely to survive
and less likely to be considered by many investors.
I looked at funds over a number of rolling three-year
periods in order to capture a variety of market
environments. I then looked at the average of those
periods to understand what was going on.
Small Caps Are the Most Bloat-Sensitive
We grouped small-cap funds by decile, then looked at
ensuing returns, success ratios, alphas, three-year
Morningstar Ratings (or “star ratings”), and informa-
tion ratios. Only the star rating is after expenses (as
well as adjusted for risk and loads).
The pre-expense returns for the least-bloated decile
were
11
.
51%
annualized versus
10
.
04%
for the most-
bloated decile. The information ratio was
0
.
31%
for the least-bloated decile versus
0
.
23%
for the most-
bloated. The least-bloated decile had a star rating
of
3
.
04
versus
2
.
69
for the most-bloated. The success
ratio for the smallest bloat decile was
43%
, and
for the bottom it was
35%
. The success ratio tells you
what percentage of the group survived and outper-
formed its peers. It is a way of preventing survivorship
bias from creeping into the data.
When Funds Get Bloated
Fund Reports
4
Fidelity Small Cap Discovery
Matthews Pacific Tiger
PIMCO Total Return
Tweedy, Browne Worldwide High
Dividend Yield
Morningstar Research
8
Buy Stock-Pickers, Avoid
Sector-Rotators, Part 2
The Contrarian
10
Freshly Minted Medalists
Red Flags
11
These Funds Are Not Worth
the Price
Market Overview
12
Leaders & Laggards
13
Manager Changes and News
14
Portfolio Matters
16
7 Common Withdrawal Mistakes
Tracking Morningstar
18
Analyst Ratings
Income Strategist
20
When the Fed Raises Rates
Changes to the 500
22
FundInvestor 500 Spotlight
23
RusselKinnel, Director of
ManagerResearch and Editor
FundInvestor
October 2015
Vol. 24 No. 2
Research and recommendatio s for the s riou fund investo
SM
Continued on Page 2