Hedgeable.com, developer of a investment platform aimed at retail investors and financial advisors, has rolled out a new mutual fund star rating system it says takes a deeper look at risk metrics than does Morningstar Inc.'s bellwether star rating system.
Specifically, Hedgeable's rating system looks at such risk measures as historical maximum drawdowns (peak-to-trough declines), value at risk (an estimate of a portfolio's market risk based on historical price trends and volatility) and largest monthly rolling losses.
These statistics are combined with downside standard deviation and historical returns over one-, three- five-, and ten-year periods to gauge how well a fund manager preserved capital and hedged risk in down markets.
"It's one thing to do well in a bull market," says Mike Kane, CEO and founder of the New York City-based company. "But it's in poor markets when you can better decide if a manager is worth investing in."
He says Hedgeable's rating system is designed to show how a fund performed across all market cycles in the past in order to better gauge how it might fare during future market volatility.
Hedgeable ranks fund managers against their peers in roughly 100 categories. It creates a curve that awards the top 10% of managers in each category with four-and-a-half or five stars, the bottom 10% with one-half or one star, and the middle 80% between one and four stars, depending on where they fall on the curve. Ratings are updated weekly.
The Morningstar fund rating system, which debuted in 1985, assigns funds from one to five stars based on a quantitative assessment of a fund's past return and risk performance. Funds are compared with their peer group across a broad range of categories. The funds are rated over three-, five- and ten-year periods, and the ratings are weighted and combined to come up with the overall rating.
According to a Morningstar fact sheet, it formerly measured risk by the fund's average underperformance to the 90-day Treasury bill. Morningstar overhauled its rating system in 2002 when it began using what it calls an enhanced risk-adjusted return measure based on "expected utility theory," which recognizes that investors are more concerned about a possible poor outcome than an unexpectedly good outcome, and are willing to give up some portion of their expected return in exchange for greater certainty of return.
The updated rating system, says Morningstar, accounts for all variations in a fund's month-to-month performance, with more emphasis on downward risk.
"This improvement rewards consistent performance and reduces the possibility of strong short-term performance masking the inherent risk of a fund and accounts for all variations in a fund's month-to-month performance, with more emphasis on downward risk," according to the fact sheet.
To gauge the different approaches taken by Hedgeable and Morningstar, Kane points to the Hartford Capital Appreciation HLS IA fund. Morningstar puts it in the large-blend category and gives it a five-star rating. Based on Hedgeable's system, Kane says the fund scored poorly on various risk metrics and merits just a one-half-star rating.
Kane, 25, formerly worked on the futures trading desk at Bridgewater Associates LP, a $75 billion hedge fund. Before that, he was an analyst involved in portfolio management at Spruce Private Investors, a money manager for ultra-high-net-worth clients.
He founded Hedgeable in April 2009 following the market crash after nearly everyone--including himself--lost money.
"After the crisis, we asked what could we have done differently, and we didn't see anything on the market that was sophisticated and had a focus on risk management needed to survive a market crisis," Kane says.
His twin brother, Matt, who also formerly worked at a hedge fund, is the company's chief technology offer and main architect of Hedgeable's proprietary technology of investment analytical tools.
The company's bread-and-butter is a web-based investment advisory platform that enables investors to build customized portfolios, provides risk management software, and makes buy and sell recommendations for any portfolio of stocks, mutual funds, or ETFs.
Hedgeable's basic plan for retail investors (suggested net worth of at least $100,000) is free. It also has more advanced plans for high-net-worth investors (at least $1 million) at $99 a month, and professional plans for financial and investment advisors at $199 a month.
Kane says financial advisors who use the site have an aggregate of $5 billion in assets under management.
The company is an SEC registered investment advisor. Kane says it hopes to start offering separately managed accounts, unified managed accounts and comingled funds in 2011.
Hedgeable's new mutual fund rating system is available on its website, www.hedgeable.com. Signing up for the site is free.