Of all the criteria I consider when I'm doing my research for the two recommendations I make each month in Champion Funds, the quality of the manager who's running the show is perhaps the most important. And I only say "perhaps" because, dyed-in-the-wool cheapskate that I am, a fund's expense ratio is also near the top of my critical list.
But really, when you get right down to it, a fund can only be as strong as the person picking the stocks. If that guy's a dud, chances are just about 100% that his fund will be, too.
While that assessment seems straightforward enough, however, what exactly does it take to make the grade as a masterful money manager? Good question, particularly if you happen to be a fan of alliteration. Not to worry: I've got an answer for you, three of 'em in fact. While the following isn't an exhaustive list, if you ask and answer these three questions before taking the mutual fund plunge, you'll go a long way toward separating the fund management wheat from the chaff.
1. How long has the manager been on the case?
Provided a fund shop doesn't hide behind the infamous "team-managed" label, getting a bead on how long a manager has been at a particular mutual fund isn't all that hard. Indeed, beginning next year, the SEC will require even those shops that do use the "team-managed" cop-out to divulge who precisely has been at the controls. So score one for the SEC -- and for savvy fund investors everywhere.
More difficult but just as important, though, is learning how long a manager has been in the business overall and what his track record has been elsewhere. That's especially true when you're trying to make a decision about whether to invest in a relatively young fund, one, say, with a track record of less than three years. If the shop has hired a seasoned and successful hand to run the fund's money, after all, that's obviously a point in its favor.
On the other hand, if the boys upstairs tapped a former international bond-fund manager for the top slot at a domestic-stock offering -- or if the new guy has no previous experience at a retail mutual fund -- consider that your invitation to keep on shopping. There are plenty of funds out there whose managers have been large and in charge since, oh, I don't know, Scott Baio first wowed us with this acting prowess on TV's Happy Days. (And let's not even discuss his fine, fine work on the criminally neglected Joanie Loves Chachi, OK?)
2. Has the manager stuck to a game plan?
But as important a data point as years of service is, it doesn't tell you a whole heckuva lot on its own. Instead, you need to gauge the tenure number relative to the manager's success (or lack thereof) as well as his willingness to stick to his strategy even when times get lean. Why so? Well, chasing hot segments of the market is almost always a recipe for mediocrity at best and significant loss at worst. Pity, for instance, the poor valuation-conscious fund manager who finally broke down and shoveled in shares of tech stocks near the market's peak in early 2000.
No, for my money, a manager who's been around the block a few times should be smart enough to know that her strategy probably won't lead to eye-popping returns in each and every market cycle. For example, value managers, who invest in low P/E picks such as ExxonMobil
And that, as Stuart Smalley on Saturday Night Live used to say, is OK. Indeed, when a fund manager's investing style is out of favor, it's a wonderful time to snap up shares of the kinds of companies she likes at a discount. In order to do that, of course, she'll have to stick to her strategic guns.
3. Does the manager invest alongside you?
As I mentioned in an earlier commentary, few details are more important than this one when it comes to determining whether a fund manager really conducts his business with your interests at heart. Shops whose managers "eat their own cooking" tend for obvious reasons to be among the most shareholder-friendly in the industry. After all, if a manager's fortune is going to rise and fall with those of his fellow investors, he's likely to do the smart things (such as keeping expenses and turnover low and focusing on after-tax returns) that help a fund make my Champion Funds shortlist.
And again, the SEC has come to investors' assistance here, too. After a new set of rules goes into effect early next year, you'll be able to see in black and white whether a fund manager is a fellow shareholder -- and just how significant his investment actually is, to boot.
When it comes to gauging management quality, you should be prepared to do battle with the wealth of information that fund companies issue -- the kind of dry-as-dust data and prose that turn up in prospectuses, annual reports, and good ol' statements of additional information. And let's don't even start about all those glossy print brochures the marketing departments dream up, OK?
Alas, for good reason, an intelligent investor regards all that disclosure as just a mere "document dump." There's just so much of it, and faced with a mountain of information, it's hard to even know where to begin. But never fear: If you're armed with the right questions -- and a cheat sheet like this column -- it really is possible to slice through the thicket of information and whittle things down to just those facts that really matter.
To that end, we'll keep on keeping on next week with a blow-by-blow account of the right way to gauge a fund's performance track record.
Shannon Zimmerman, editor and analyst of Motley Fool Champion Funds, slices, dices, and has even been known to breakdance on occasion. He doesn't own any securities mentioned. The Motley Fool is investors writingfor investors.