These insights are great for individual security investors, but fund investors can also take a page from the Oracle’s playbook by analyzing aggregated characteristics of funds’ underlying portfolio holdings.
In the previous posts, several factors were noted as relevant from the Buffett philosophy, including investment size, valuation, return on equity, debt relative to equity, earnings growth, and industry concentration. We can filter fund investments based on these factors—as well as those favored by other star investors—in a screening application. For example, fans of Peter Lynch, who managed the incredibly successful Fidelity Magellan fund from 1977 to 1990, might also add factors indicating investment concentration (to avoid the hazards of “diworsification”) and corresponding to the potential for dividend increases.
To this end, we can use a multi-factor ranking scheme in a screening workflow to uncover the funds that are most likely to adhere to the philosophies of the legendary investors. In a screen I built to demonstrate this approach, I used factors to determine fund ranking that include variables subscribed to by both Buffett and Lynch:
Concentration—higher Herfindahl-Hirschman Index score ranks better
Dividend Yield—a blend of higher dividend yields and lower payout ratios rank better
Valuation—a lower blended score of P/E and P/Book ratios rank better
Profitability—a higher blended score of return on equity and net margin rank better
Quality—a lower debt to equity ratio ranks better
MSCI ESG Fund Rating—more ESG “Leaders” in the fund portfolio rank better
This particular ranking scheme seems to create a bias towards international equities, but we can mimic the domestic preferences of Lynch and Buffett by grouping results by a fund’s exposure to regions or countries of domicile. Alternatively, we could group funds by exposure to the actual geographic source of revenues, rather than the domicile of the holding.
For example, I grouped funds by whether they had greater than or less than 90% domicile exposure to developed markets. Looking at a predominantly developed market fund, SEB Nordenfond, a Nordic open-end mutual fund with a bias towards financial equities, rose to the top of the list. Though at first glance this fund seems heavily concentrated in Nordic nations (more than 96% of holdings are domiciled in Sweden, Norway, Finland, or Denmark), the actual source of geographic revenues shows a far more balanced picture, with those nations accounting for just 38% of total revenue exposures.
SEB Nordenfond returned a balanced score across all variables in our screen, with a top decile score in sales growth and second decile scores in net profit, return on equity, debt to equity, and, for the sustainable investors, by percentage of portfolio market value comprised of MSCI ESG Leaders. The fund scored lower in valuation variables—fifth decile for P/E and P/B and fourth for dividend yield and payout ratio—but a mid-ranking valuation with top growth, profitability, and quality scores was enough to bring this fund to the top.
Though analysts of the fund’s underlying holdings place the target price of the fund at an 8.7% premium to the current price, which is shy of the 9.1% premium for the S&P 500, the fund has outperformed in recent years. Over both the three- and five-year horizons, the fund has realized double-digit annualized returns—echoing the results of the legendary investors and affirming the principles they espouse.
Michael is responsible for guiding strategy and development for FactSet’s benchmark data feed solutions. Prior to this role, he was a Product Manager developing aggregated market statistics for countries, industries, benchmarks, and investment funds for the FactSet Market Aggregates (FMA) product group. In his prior role, Michael wrote research briefs that were cited by numerous financial publications. Michael joined FactSet in 2011 and is based in New York City. He holds a B.A. in Finance from the University of Notre Dame and is a CFA charterholder.