Fund Scores provide a refreshingly simple way to choose between winners and losers in the fund landscape.
We have a new update to our Fund Score Whitepaper, which can be accessed here. The paper can also be accessed under the Media & Education page through the Whitepapers link. Highlights from the paper are included below. As always, please reach out to us with any questions.
Over the years at Nasdaq Dorsey Wright, we have created many innovative technical indicators based on momentum. One of our most popular indicators is the “Fund Score” rating we apply to each mutual fund/ ETF. The rating ranges from 0.0 (lowest strength) to 6.0 (highest strength) with values of 3.0 or higher generally regarded as investable.
The purpose of this study was to determine how effective fund scores are from a portfolio management perspective. If we buy simulated portfolios of funds with high scores, do we outperform an equal weighted basket including all funds? Alternatively, what happens if we buy simulated portfolios of low attribute funds? We found that simulated portfolios with high scoring funds had a strong propensity to outperform, with the largest outperformance reserved for the highest scores (5.00+), while low fund score simulated portfolios had a marked tendency to underperform.
Fund Score Study
To determine how fund scores work in a simulated portfolio management context we first calculated fund scores for all open end mutual funds (excluding alternate share classes and money market funds) from 1992-2024. Next, we constructed six different equal weighted simulated portfolios (one for each integer range fund score rating). The 5.0 - 6.0 fund score simulated portfolio, for example, would own every fund with a score between five and six, while the 4.0 - 5.0 simulated portfolio would own every fund with a score between four and five, etc. Finally, we reconstituted and rebalanced these simulated portfolios at the end of every month to account for changes in the fund scores over time. The graph below shows the cumulative performance of these simulated portfolios along with the performance of an equal weighted index we calculated comprised of every open end mutual fund (EQW).
Buying a simulated portfolio of funds with a score between five and six outperformed the average fund by a large margin (10.94%/year vs. 6.42%/year) in this simulated study the simulated portfolios that buy fund scores between four and five also outperformed the average fund (8.59%/year vs. 6.42%/year). Low score simulated portfolios, on the other hand, tended to underperform the equal weighted simulated portfolio. Scores between 0 and 1, in fact, posted a negative yearly return on average (-0.05%/year).
From a risk perspective, max drawdowns, standard deviations, and Sharpe ratios also improved as you move from the low fund score simulated portfolios to the high fund score simulated portfolios. In fact, even though the five-six fund score simulated portfolio outperformed the average fund by 4.52%/year, it did so with only 312 basis points of
additional risk as measured by its standard deviation. In turn, this allowed it to have a 61% higher Sharpe ratio. Yearly returns were also very positively skewed. The worst relative yearly performance to the equal weighted simulated portfolio was -10.23% in 2011 while the best relative yearly performance to the equal weighted simulated portfolio was 32.22% in 1999. The five-six fund score simulated portfolio also outperformed the average fund 86.70% of the time on a rolling three-year basis.
That may all be interesting, but a client cannot hold every 5.0-6.0 fund score fund in his/her portfolio. To do so, they would have to hold, on average, around 476 funds. How does this behave for a more manageable portfolio of 20 funds? To test this, we created a simulated portfolio of 20 funds with a score between 5.0 and 6.0 at random every month over the test period (1992-2024). We then ran that simulation 100 times to see how often it outperformed.
The chart below shows the number of random simulated portfolios at each CAGR level (grouped into 0.5% increments). As expected, most simulated portfolios exhibited returns in or around the average of the “Buy All 5.0-6.0 Fund Scores” simulated portfolio (10.94%/year). What’s interesting though is that every random simulated portfolio beat the equal weighted portfolio, and 100% of them even managed to beat it by 3%/year.
