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Kinnel's Tips on Do-It-Yourself Fund Screens

Be open to passive and active investing

Russel Kinnel 07/12/17

Fund industry has grown massively, and it has changed to a better-run, more professional, and lower-cost business where leadership is more robust and less personality-driven. That’s all to the good, even if it means the fund world is a little duller. Funds are better at spelling out how they invest, and technology makes it easier for us to see what our entire portfolio of funds and stocks looks like together. A subtle change is that investors continue to use funds to add more diversification. Hence, what indicators investors can use to screen and select the most ideal funds? Morningstar Manager Research Direcor Russe Kinnel shared his tips on finding the most ideal funds; on the other hands, he shared lessons he learned over the years on investments.

Tips on screening active funds

If I'm crafting my own screen for mutual funds, what are the data points that I should be sure to embed in whatever screen I'm running? Low expenses tend to predict better performance, so expense ratios are a good starting point; and compare them with an average.There other factors at the same time are widely accessible, which can make decent components of screens. Manager tenure is a good one, and essentially five-year manager tenure is ideal. Also rather than looking at a standardized time period, look at the period of the manager's tenure. It is not that as predictive value, but if you're looking for new fund ideas that would be helpful to narrow the list.

Now, let's talk about performance, because a lot of times at the top of screening tools that you might use, you might see that you can screen on three-year or five-year performance. But Kinnel would not put a big emphasis on performance. In his opinion, you could say, I want funds that returned more than 8% a year over the last five years, which to him is really silly because it doesn't tell you if that's really good performance or really bad performance relative to a peer group. It could be too short term. He personally doesn't really like three or five years. Also, past performance obviously just has some limits. You don't want to lean too heavily on past performance because it's not a very good predictor on its own.

And if any available search tools can provide risk screen, that would be helpful. You can just screen on any kind of standard deviation or other risk measure--just the idea is to screen out the really high-risk funds, not to screen for super low risk only; if so, you might end up taking on big opportunity costs by just focusing on really low-risk funds.

Tips on screening passive funds

In terms of the active versus passive divide, should I approach this screen process differently? Or, how should my screen look different, if I'm someone who is used to active funds, but willing to consider passive funds as well? Kinnel suggests to probably make a difference. The first is, leave out the manager tenure screen. It's not too important. Passive funds tend to be really team-managed. In a lot of passive funds, the management part is not that hard. It's important that you have skilled, experienced people, but at the same time it's generally not the most important part of the process.

Then, performance, Kinnel suggests to leave that out entirely, because again, if you are looking for low costs, you are not looking for something that beat the benchmark. He suggests to leave out performance and manager-driven pieces. Volatility is still a legitimate thing to look at. Obviously, fees should be doing a lot of the heavy lifting for you though.

If I'm simply looking for funds that are below category average, that's probably not going to do a lot for me, even if I'm looking for passive products, right? I think at a minimum you might set an expense screen of basis points, and then you might want to rank on expenses and to combine with category average as a starting point.

Apart from building a plan for multiple investment goals and stick to it; align your investments with each goal, Kinnel shared following lessons learned from investments:

  • Be open to passive and active investing.
  • Build from the core out. Make sure most of your money and attention goes to core equity and fixed-income funds. It’s easy to get excited by hot performers and exciting niche funds, but a whole portfolio of those funds is just a giant mess.
  • Choose funds that are good bets to be keepers five years from now because they have depth of managers and analysts, low costs, and strong stewardship to keep them on the right path.
  • When monitoring funds, pay more attention to management and costs than changes in performance.
  • Be patient. Even the best managers will underperform in a three-year period. If the management and strategy are still strong, keep the faith.
  • Keep costs low, but evaluate whether some services are worth the price if you don’t have the time to do it yourself.
  • Don’t worry about a fund’s net asset value. I’ve also heard people interpret NAV like it is a good indicator of total return. It isn’t. Funds make distributions along the way that reduce NAV.
  • Don’t let the price you paid for an investment drive your decision on whether to sell. I’m amazed when people tell me they are going to hold on to a losing investment until they get back to even. If it’s a bad investment, move on. Think instead about returns. If you think one fund will return 5% a year and one in the same category will return 10%, it doesn’t make sense to wait before switching to the 10%.
  • Do not let the news drive your investments. Markets price in the news probably before you’ve even heard it. Even the smartest investors have difficulty making money by predicting economic trends or choosing which countries will be winners. 
  • Invest automatically through an automatic investing plan you set up yourself. The results are great because they enforce a discipline that keeps emotion out.
About Author Russel Kinnel

Russel Kinnel  

Russel Kinnel is Morningstar's director of mutual fund research.