In part I believe what Morningstar is trying to do is discourage fund groups and brokers from pushing hot funds, so it could actually lead to lower marketing costs.

I actually question the need for large marketing budgets for funds. If a fund has good results I guarantee that money will find it. If a fund has mediocre or poor results, marketing is all they have to bring in new money.

In addition to not advertising hot funds, fund groups also can (and some have), close funds to new money or as Mike points out raise cash by letting the new money stay in cash. With the latter approach, investors can decide whether they want to hold that much extra cash by moving out of a fund that is doing that, or commiting more money to the fund to keep the same amount in equities (or bonds), though from my experience if we’ve bought an active fund, its because we’ve judged management to be superior in a particular area, and I’m very willing to let them decide if an area is so overvalued that they need to hold a lot of cash- you can look at a fund like First Eagle Global and see that practice has led to higher long term returns not lower.

This new measure certainly won’t be a perfect indicator, particularly if its used to compare single funds to indices. As an example, if you had only $10 million for the first six months of the year, and then $500 mil for the second half of the year, the new indicator would be heavily skewed towards what happened to the markets in the 2nd half. To make any index comparison appropriate, you’d need to know how the $490 million was invested in the first half of the year. I wonder if fund group asset weighted results wouldn’t be a better measure to include in stewardship grades?

In the end, I guess if it reduces how much the industry feeds poor investor behavior it would be a good thing.

On a side note, I had no idea there was so much fluctuation in assets under management for the large funds. Frankly, I don’t see how there could be such a large variation with these multi-billion dollar funds. In portfolio management software, when there are big differences between IRR and TWR, usually something weird happened. Like a client adding $1M to a $100k account five days before the end of the period.

“In contrast, the quartile of funds with the lowest relative volatilities exhibited dollar-weighted returns that, on average, were 98% of their time-weighted returns.”

So what we are really trying to measure is the volatility or risk of the fund and performance is the wrong metric to do that. I do think this is unfair to the fund managers as they really do not have control over the timing of cash flows into or out of the fund.

Sure, as the article points out:
“Fund companies can influence investor behavior through fund design, the timing of launches and closings, marketing efforts, and shareholder communications”

How exactly do I design a low volatility small cap emerging market fund? With all the other solutions (marketing efforts, shareholder communications etc…) I see an increase in fees, how else will the fund company pay for these efforts?

Maybe, as you indicate they will reinstate short-term withdrawal fees which limits the investor’s ability to change funds or goals. However they do it, it means more cost to the investor.

Another solution will be to keep more money in cash, lower returns but also lower volatility. If this measure becomes important this could be a solution, unfortunately it would punish all of us buy and holders with lower returns over time.

What this really tells me is that a lot of investors need better financial managment to help take the knee jerk reactions out. The TWR is the return that an investor will get if they buy and hold the fund. This extra measure is likely to confuse more investors than help them.