Investment manager selection

6 steps to enhance manager selection

Relying simply on cost and past results to select investments may not be the best approach to satisfying fiduciary requirements. These six screening factors can enhance the investment manager selection process for equity-focused funds and increase the odds of finding investments that can deliver strong results.

Downside capture

Low expenses

Manager ownership

Privately held


Long-term orientation

The first 3 factors build on each other

A combination of these three traits identifies a small group of equity managers that have on average outpaced passive funds.

Downside capture

Why it matters:
Downside resilience is a key to strong results via better risk characteristics.

Screening criteria:
Funds that spent most rolling periods in the best two quartiles of downside capture vs. peers

Low expenses

Why it matters:
Less cost lowers the hurdle to achieving strong investment results.

Screening criteria:
Funds within the lowest quartile of expense ratios vs. peers

Manager ownership

Why it matters:
Managers should have a personal stake in outcomes.

Screening criteria:
Top-quartile measures of manager ownership at the firm level


Average annual advantage over passive peers

After-fee asset-weighted average annual return (1999-2018)

Source: Capital Group calculations based on monthly Morningstar data (1999-2018). Large-cap domestic funds are actively managed open-ended and exchange-traded funds in the Morningstar Large Value, Large Blend and Large Growth categories. Active funds with low downside capture, low expense ratios and higher firm manager ownership is a group of active funds that are first filtered by identifying funds having a downside capture ratio (relative to the S&P 500 benchmark) that places them in the top 50% of their Morningstar peers over a majority of rolling three-year periods. We then filtered that group for the funds that are in the top quartile of both low expenses and fund firm high manager ownership. Past results are not predictive of results in future periods. There have been periods when active funds meeting the criteria have lagged indexes. The U.S. large-cap universe was chosen because it is the largest Morningstar equity fund category by assets. Please see the Exhibit methodology section for more details on how we tracked low expenses, high manager ownership at the firm level, and low downside capture. Passive peers are defined as index funds (both ETFs and open-ended) within the Morningstar Large Blend category. The Morningstar Large Blend category is used to represent passive peers for two reasons. One, the S&P 500 is classified as a blend index. And two, the Blend category is by far the largest (outpacing Value and Growth) in terms of industry assets.

The next 3 factors stand alone

These three cultural values can further narrow the universe of investment managers.

Privately held

Public ownership can distract and create a short-term focus.

Screening criteria:
Large, privately held investment management firms



Median annual return advantage


Fund closures are disruptive for participants.

Screening criteria:
Large fund families in the top quartile of survivorship


Average annual return advantage

 Long-term orientation

Managers should align with a long investment time horizon.

Screening criteria:
Low portfolio turnover and manager compensation that emphasizes long-term results

Lower trading costs

Source (Privately held): Capital Group calculations based on Bloomberg data on firm ownership as of 2016 and Morningstar monthly return data (1998–2017) with assets under management of $10 billion or more as of 12/31/2017. To calculate this data, we compared privately owned and publicly owned dedicated asset management firms (i.e., firms that do not offer additional products or services). Excess return advantage is based on an asset-weighted composite of each family’s funds (all funds) versus a similar asset-weighted passive composite, then taking the difference between privately owned asset managers and publicly owned managers. Expenses are as of 12/31/2017, based on each fund family’s asset-weighted composite (all funds).

Source (Survivorship): Capital Group calculations based on monthly Morningstar data (1990–2017 for survivorship rate, 1998-2017 for historical excess return) and measured at the fund family level (equity funds only). Please see the Exhibit methodology for more detailed methodology on how this exhibit was calculated. Values may not reconcile due to rounding.

Source (Long-term orientation): Capital Group and Morningstar. The portfolio turnover ratio indicates the approximate share of portfolio holdings that have changed over the previous 12 months. It is calculated by dividing the amount of a fund’s total security purchases or sales (whichever is less) by the fund’s average monthly net assets.

A better way to select investment managers

Why it matters: Higher returns mean better outcomes

Just a 1% increase in returns can result in 13 additional years of spending.

Based on a hypothetical scenario: $40,000 initial salary, 3% annual salary inflation and 10% annual contribution starting at age 25. Withdrawal rate under all three scenarios is 50% of ending salary ($65,241).

Source: Capital Group. The demographic assumptions, returns and ending balances are hypothetical and provided for illustrative purposes only, and are not intended to provide any assurance or promise of actual returns and outcomes. Returns will be affected by the management of the investments and any adjustments to the assumed contribution rates, salary or other participant demographic information. The additional years of retirement spending are intended to represent a conservative measure. Actual results may be higher or lower than those shown. Past results are not predictive of results in future periods. Based on an exhibit from Russell Investments.

Exhibit methodology

Asset-weighted methodology: Wherever possible, the Capital Advantage® research findings are based on asset weighting rather than equal weighting. Exceptions are noted and explained where applicable. Asset-weighted comparisons used in this piece use the following process: for each equity-focused fund, we gathered the respective net returns and asset sizes for all the share classes available for each period. At this level, the returns are then share class-weighted, which means the returns are asset-weighted according to the share of assets associated with each share class within each fund. Each fund is then delineated by whether it is active or passive, then grouped into its respective Morningstar category. Additionally, the survivorship rate is accounted for (i.e., once created, we accounted for whether the funds have merged or closed during the measured period. In those cases where a fund is merged or closed, its asset-weighting is adjusted to zero and its assets are distributed to all other funds in the category. For newly created funds, the weight of that fund is zero until the period in which it has reported assets, whereupon we use the standard asset-weighting to weight the returns based on asset size.). This methodology is used to more effectively portray the likely experience of market participants in the analyzed period versus an equal-weighting methodology, which is more appropriate when analyzing the performance of a specific fund over time, regardless of the size of its assets. Additionally, asset-weighting is often more appropriate when analyzing the results of an investment in an entire fund category. For example, the return of a $10 billion fund would count for 10 times as much as the return of a $1 billion fund. From there, as a fund’s assets grow or shrink relative to other funds, its effect on the category return would increase or decrease as appropriate.

Tracking low expenses and high manager ownership: In conducting our research, we searched Morningstar’s database for large-cap actively managed funds that were in both the lowest quartile ranked by expense ratio and the highest quartile ranked by manager ownership at the firm level. For this analysis, we relied on Morningstar Direct data analysis software. Least expensive quartile was calculated using annual report Net Expense Ratio (NER) for all observed Morningstar categories for the period indicated. For share classes with missing expense ratios, gaps between two available data points were filled in using linear interpolation. Linear interpolation is a statistical method used to estimate the values between two known data points in a time series. After interpolation of share class expense ratios, fund expenses are based on an average of the expense ratios of the underlying share classes where each share class is weighted according to the amount of assets it had at the time relative to the fund as a whole. Highest manager ownership quartile was calculated using weighted averages of Morningstar screens of manager holdings at the firm level. Each fund was assigned the weighted average of its firm manager holding. Funds without values were excluded from the quartile rankings. The combination of least expensive NER and highest manager ownership quartiles was the result of a cross-section of the two screens. Only those funds with both the lowest expense ratios and the highest manager ownership were included.

Size of quartiles varies because those funds in the Morningstar database that did not include an expense ratio or firm-level investment ownership were excluded from the analysis.

The Securities and Exchange Commission (SEC) requires that mutual funds disclose all fees and expenses in a standardized table published in the front portion of the fund prospectus. The SEC also requires that a fund disclose in its statements of additional information (SAI) certain information about its portfolio managers, including ownership of securities in the fund. Ownership disclosure is made using the following seven ranges: none; $1 to $10,000; $10,001 to $50,000; $50,001 to $100,000; $100,001 to $500,000; $500,001 to $1,000,000; and over $1,000,000.

Downside capture: Capture ratio reflects the annualized product of fund versus index returns for all months in which the index had a positive return (upside capture) or negative return (downside capture). Downside capture versus the appropriate market benchmark is calculated annually for every share class (alive and dead). A share class must have at least 36 months of returns to generate a capture result. Downside capture for each category is weighted by each fund’s average net assets by year.

Privately held: As of 2017, we classified larger fund families as those with at least $10 billion in assets as well as those with at least 10 years of return history as of 2006, which were then categorized by whether they were publicly (i.e., owned by public shareholders) or privately held. The results were then categorized by whether the fund families were managed by dedicated asset management firms or were part of an organization with other products or services, including banks, insurance companies and institutional financial services. We then compared the returns of all private versus public dedicated asset managers and the returns of privately owned asset managers versus all public financial institutions, including dedicated asset managers.

Survivorship: Family fund survivorship is calculated based on the ratio of live funds to total funds (which includes live, liquidated and merged). Fund family excess returns (based on the excess return of equity funds over their respective stated primary benchmark) are time-weighted (funds with more history are weighted higher) and are generated by all equity funds offered by the family at any point in time. The exhibit focuses on peer fund families that manage over $10 billion in assets under management and have generated at least 20 years of returns as of 2017. To create the fund family composite, we weight these funds according to the amount of assets they have at a given time. These numbers are calculated over the full 20-year period and then annualized.

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