Fund Diamond Ratings

AthenaInvest has developed a fund measure that captures both strategy consistency and strategy focus, which we call a Fund Diamond Rating (DR). DR5 funds are those that are most strategy consistent and most focused on best stock ideas, while DR1 funds are the poorest along both of these dimensions.

The first dimension, strategy consistency, is described in the previous section. The second dimension , Strategy focus, captures the extent to which a fund sorts through the hundreds of own strategy stocks in order to find the manager’s best ideas. This can be measured in several ways, including the number of stocks held (the fewer the better), assets under management or AUM (the smaller the better), best fit index R-Squared (the lower the better), active share (the higher the better), style box drift (the higher the better), and tracking error (the higher the better).

As of August 2009, DR5 funds held the fewest number of stocks (64); had the highest active share (94%), the lowest R-Squared (0.75), and the highest strategy consistency (72 out of a possible 100); experience somewhat higher turnover, management fee, and expense ratio; and are the smallest ($140mil AUM). The smaller average size may contribute to the higher costs since some expenses, such as audit and blue sky fees, are fixed and have a greater impact on smaller funds.

Forward-looking performance falls right in line with Diamond Ratings, as the average DR5 fund beats the average DR4 fund, and so on down to DR1 funds. DR5 funds have an average fund standard deviation that is only slightly higher than the average fund, so higher DR5 returns are not accompanied by commensurately higher volatility.