Terrible Twos? The two-year-old funds which are most out-of-step with their peers …

We thought we’d start catching up with the 130 U.S. equity funds which have passed their second anniversary but have not yet reached their third, which is when conventional trackers such as Morningstar and Lipper pick them up.


As Charles has repeatedly demonstrated, the screener at MFO Premium allows you to answer odd and interesting questions. I’ll try to look at several questions over the next week, starting with “which of these new funds might be badly miscategorized?”


That’s an important question, since investors tend to buy the (Morning)stars. In general, that’s an okay decision: five star funds rarely become stinkers, one star funds rarely become gems. Except when a fund has gotten dropped in an inappropriate peer group, so that Morningstar is looking at a banana and trying to judge it as an apple. Our two favorite examples are RiverPark Short Term High Yield (RPHYX) and Zeo Strategic Income (ZEOIX). Both are outstanding at what they do: generate low single-digit returns (say, 2-4%) with negligible volatility. And both get one star from Morningstar because they’re being benchmarked against funds with very different characteristics.


How did we check for miscategorized funds? Simple, we get our screener to identify all U.S. equity funds that had been around for under three years. We downloaded that to Excel, eliminated funds with under two years of history then sorted them by their correlation to their peers. We found that over half of the funds were indexes or closet indexes (correlations over 95, with some “active” funds at 98). Just six funds, three active and three index, had correlations under 75.


Cambria Value and Momentum ETF (VAMO, as in Vamoose?) has the lowest correlation (0.43) with peers of any of the two-year-olds. Lipper thinks it’s a large cap value fund. Why should you care? Because a low correlation with the peer group raises the prospect that a fund has been miscategorized and it makes it very likely that any rating it receives – positive or negative – will be unreliable. One illustration of that possibility: 5 of 6 six low correlation funds trail their peer group with VAMO lagging by 14% annually. Does that mean they’re bad funds? No, it means that its strengths and weakness can’t be predicted from its peer group.


The other two-year-olds with peer group correlations under 0.75 so far:


HTDIX – Hanlon Tactical Dividend and Momentum Fund (Lipper: Equity Income)

PTMC – Pacer Trendpilot 450 ETF (Mid-Cap Core)

BMVIX* – Baird Small/Mid Cap Value Fund (Small-Cap Core)

PTLC – Pacer Trendpilot 750 ETF (Large-Cap Core)

FSUVX – Fidelity SAI US Minimum Volatility Index Fund (Multi-Cap Core)


Note: BMVIX is actually just shy of 2 years through October, but I want to touch on it for December commentary.


Next up: two-year-olds leading their packs.