is Rigged
Don’t Bet on the Winners
April 21, 2009
Advisor Perspectives welcomes guest contributions. The views presented here do not necessarily represent those of Advisor Perspectives
Looking at Morningstar’s chart below, you would easily conclude that value managers beat their benchmarks in the first quarter of 2009, while their large-cap growth counterparts failed miserably.
And you would be wrong. This horserace is rigged, as are all peer group rankings.
The white triangles in the chart above show the percentage of managers who outperformed their benchmark. For example, 96.03% of mid cap value managers outperformed the Morningstar mid cap value index, while only 7.04% of large cap growth managers outperformed their index. Morningstar is saying that active value managers added alpha and active growth managers subtracted alpha. But this is an erroneous inference.
In a recently published article, I explain the fallacy of peer group methodologies. Peer group providers establish rules for classifying managers as large or small, value or growth, etc. and then populate their peer groups with managers that meet these criteria. Some peer group providers use manager categorizations of themselves while others apply criteria like correlation to an index or holdings-based profiles.
Regardless of the methodology, a little known bias creeps in, called “classification bias.” As I say in the article: “Classification bias feeds on the lack of similarity among the funds that meet these classification rules, enveloping manager evaluations with scary ratings. It is an amorphous bias that cannot be made to go away, try as we may. We need to think outside the box to rid ourselves of this blob.” It’s like staging a race for brown horses only.
Display article as PDF for printing.
Would you like to send this article to a friend?
Remember, if you have a question or comment, send it to .
