Data used by Morningstar Inc. to evaluate the performance of mutual fund categories “systematically and significantly” overstates investment returns, according to a study released Wednesday by Savant Capital Management of Rockford, Ill.
According to the 28-page study, actual returns were inflated in 41 of the 42 investment categories tracked by Morningstar, the industry-leading Chicago-based fund researcher.
The study is available at www.zeroalphagroup.com.
The Savant study focused on actively managed funds and the concept of “survivor bias” in which fund rating agencies like Morningstar exclude failed mutual funds when rating investment categories such as large-cap growth, small-cap value and mid-cap blend.
In purging the weakest funds, Morningstar’s average category performance increased by 1.6 percent per year during the 10-year period studied, according to Savant.
Only the “small capitalization growth” category improved when the dead funds were included, the study showed.
“Fund companies kill their worst performers and sweep them under the rug,” Brent Brodeski, the study’s co-author, said Wednesday during a conference call. “In the process, investors are duped.”
The study claims to be the most comprehensive of its kind, analyzing every major mutual fund and investment category tracked by Morningstar from 1995 to 2004.
Brodeski’s firm is a wealth manager that touts index funds that automatically track a basket of stocks such as the S&P 500 or an industry sector such as energy or transportation.
The study does not question Morningstar’s reporting accuracy of individual fund performance.
Mutual funds are one of the most widely held investments, with more than $9.1 trillion currently under management, according to the Investment Company Institute, a trade group.
Morningstar is the nation’s most popular fund researcher. Investors and financial professionals use the company’s five-star system to help select mutual funds, assess fee structures and measure performance.
Don Phillips, a managing director with Morningstar, said his firm – and other researchers, including Denver-based Lipper Inc. – does not account for survivor bias when analyzing fund categories. He said investors and financial professionals rarely ask for that information.
“The average investor wants to know, ‘How does the fund stack up to other funds that are currently available?”‘ he said.
Even so, he said Morningstar began this year to craft a database that will account for survivor bias. The database is scheduled to be publicly available next year, Phillips said.
Shelley Peterson, a spokeswoman for Denver-based mutual fund giant Janus Capital Group Inc., said that survivor bias can help investors.
By weeding dead funds from category evaluations, investors get a better sense of how individual funds compare with their active peers in a category.
“If you are an underperforming fund, you shouldn’t survive,” Peterson said.
Staff writer Will Shanley can be reached at 303-820-1260 or wshanley@denverpost.com.
