Forging the coveted gold medals

Morningstar's Danielle LeClair on uncovering fund potential through people, process, and parent evaluation

Forging the coveted gold medals

This article was produced in partnership with Morningstar.

The process of selecting a mutual fund goes far beyond merely examining past performances. It's akin to dissecting a recipe ingredient by ingredient. Understanding each component's role and how they blend together is crucial for the final outcome. Morningstar’s Head of Manager Research for Canada, Danielle LeClair strongly believes in the importance of understanding a mutual fund’s personality, its management approach, investment philosophy, and how it complements an investor's overall portfolio strategy.

The head of research likens evaluating mutual funds and ETFs to assessing a culinary operation, where the investment team’s strategic approach is a carefully constructed recipe, and the managing firm is the restaurant itself. Understanding the investment process is crucial; involving examining how the team utilizes their available tools and makes projections, which collectively form the foundation of portfolio construction.

People, process and parent

LeClair emphasizes leaning into the pillar process to assess the personality of a fund strategy. The pillars are people – gaining insight into the team crafting the strategies, their backgrounds, thought processes, and qualifications. The second focus being process where Morningstar assesses whether the fund management’s approach is distinct and if they possess the capability to deliver stable returns while managing risks. The third aspect pertains to the overseeing entity or the asset management firm backing the strategy. The parent - delving into the firm's culture, how it supports its analysts and investment professionals, and whether this support translates into the fund's performance.

“Ultimately, by integrating these evaluations and considering the cost, we determine if a strategy has the potential to surpass its benchmark and peers. Our goal in identifying a Gold-rated fund is to find standout options in these areas that with a high probability of providing consistent returns for investors,” LeClair says.

The medalist rating and its impact

In 2017, recognizing the vast universe of funds and the limitations of covering them all through qualitative analysis alone, Morningstar launched the Morningstar Quantitative Rating for funds. This innovative approach employed algorithmic techniques to extend ratings to those strategies and vehicles not covered by the analyst team. The Quantitative Rating aimed to replicate the decision-making process of Morningstar’s analysts as closely as possible, using a data-driven model to evaluate the potential of various investment vehicles.

The most significant leap forward came in 2023 when Morningstar integrated the Analyst and Quantitative Ratings into a singular, forward-looking framework known as the Morningstar Medalist Rating. This integration marks a pivotal advancement in investment analysis, merging the depth of qualitative insights with the breadth and scalability of quantitative assessments.

Qualitative and quantitative assessments

LeClair combines qualitative insights with quantitative data, utilizing tools like Morningstar data for an in-depth analysis. This includes examining tenure, fund management history, and performance under various market conditions.

“From a quantitative perspective, we leverage Morningstar data to evaluate factors such as tenure, indicating how long a manager has been associated with a fund, and the variety of funds they have previously managed. This analysis helps us gauge their experience and adaptability across different fund types. Through attribution reports, we can determine whether a manager's success stems from asset allocation or security selection and identify the market conditions in which they excel,” notes LeClair.

Evaluating a portfolio manager and their team's understanding of their investment strategy's strengths and weaknesses presents a qualitative challenge. On the qualitative side, personal interactions with managers offer invaluable insights. It's common to hear claims that a fund will outperform in all market conditions, but the crucial question is how well the team grasps their fund's concept and process. To verify their hypotheses, Morningstar relies on quantitative data.

LeClair says, “We scrutinize the holdings over time to understand the fund's performance and strategy execution. If a manager professes to be a long-term investor, yet exhibits frequent trading, this inconsistency raises questions about the alignment between their stated strategy and actual practice. Both confirming and refuting these aspects from a qualitative standpoint involves a detailed examination of behaviors and outcomes.”

LeClair also stresses that Morningstar’s analytical framework applies equally to ETFs and mutual funds, challenging the misconception that their analysis is limited to mutual funds.

The future of fund analysis

The influence of AI across all sectors is undeniable, marking a significant shift in how we approach and analyze data. Despite this technological evolution, LeClair firmly believe that the role of human analysis in assessing funds cannot be entirely supplanted by machines or quantitative algorithms. 

“The influx of information aids in refining the questions we pose to portfolio managers, enriching our interactions and the depth of our investigations. The excitement surrounding technological advancements and their impact on data analysis is palpable and positive, driving the demand for greater transparency in investments.

“Looking forward, the prospect of increased data availability from asset managers is encouraging. This trend towards openness and accessibility of information promises to further empower investors and analysts alike, fostering a more informed and transparent investment landscape,” says LeClair.