I was talking with a fund manager this week when the conversation turned to sports and how “March Madness” has gripped his office.
The basketball phenomenon of March Madness – starting with conference tournaments, leading to the NCAA Tournament and finishing with the crowning of a national champion – is an obsession for a lot of sports junkies. The manager being one of them, he started breaking down which teams should make the “Big Dance.”
The more he talked, the more it became clear that the same elements that put a team into the tournament are involved in putting a mutual fund in an investor’s portfolio.
The result is a bit different – you’re trying to “set the field” for your portfolio rather than crown a champ – but the analytical factors are the same.
With that in mind, here’s something for basketball fans and fund owners to try during the lulls in March Madness: See if your holdings have earned a spot in your field. When you find a fund that is “on the bubble” – meaning it’s not an obvious choice to buy again today – you’ll have a “watch list” of funds that may, in time, deserve the boot.
Here are the factors that get a school into the Big Dance, and that should factor into a fund making your portfolio:
The conference they play in: In hoops, there are “power conferences” – where a sixth-place team might make the tournament – and “mid-major conferences,” where often only the tournament champion goes. In mutual funds, there are asset classes.
Your search for a fund should start by deciding the type of assets you want. If you want a large-cap growth fund, you have a huge category with a lot of “teams” to consider. If you want a small-cap value fund, there may be few top options open to new investors.
In smaller asset classes, you’ll only want to pick your version of the “conference champ.” In the bigger categories, you may opt to diversify into two or three funds.
As you build your portfolio, you want to have funds from different asset classes, which provides you diversification and smooths out the ride.
A fund is allowed a bad year, but you want to see how it bounces back, and the peer group comparison is key in deciding if the fund is good enough, or if you might want to side with the competition.
If a fund only does well when everything is working in its favor, it may just be riding the tide in the market.
Morningstar’s five-star system, for example, is a risk-reward calculation designed to say if the fund delivered a reasonable return for the amount of risk it took. Lipper Inc. breaks fund performance down into five categories and gives number grades in each.
No matter the provider, ratings and rankings are meant to be descriptive (based on what a fund has done) rather than predictive (based on what a fund will do). That means that these systems can’t be the sole basis for choosing a fund. That said, they’re a factor that helps you separate one option from another, contributing to your comfort level with the funds you own.
Chuck Jaffe is senior columnist for MarketWatch. He can be reached at jaffe@marketwatch.com or at Box 70, Cohasset, MA 02025-0070.
