What are the selection criteria of funds for the Model Portfolio and the Best of Ideas Funds?

Fund Selection Process MeDirect works closely with Morningstar Investment Management Europe (MIME) to define a bespoke fund universe or portfolio of funds to support specific investment goals. The fund selection process is comprised of the following quantitative and qualitative phases:  Determining asset allocation Before selecting individual funds, Morningstar looks at the composition of the portfolio in terms of stocks and bonds (the so-called asset classes), and examines its geographical and sectorial allocation. Quantitative Screening Morningstar applies a ranking process that considers the Morningstar Risk-Adjusted Return benchmark. Other factors that are taken into consideration are: Performance consistency – if a manager has consistently performed poorly in three out of the last four calendar years, the fund will typically be removed at this stage. Empirical evidence suggests that long term poorly performing funds will continue to perform poorly going forward. Manager Tenure – If a manager has been running a fund for less than three years, they will typically be removed from the selection. Style – If the fund displays erratic changes in style, it will typically be removed at this stage. Currency – If a multi-regional fund search is undertaken, those funds that do not have an offering in the base currency of the intended users will typically be removed from the selection. Qualitative Evaluation The purpose of the qualitative selection methodology is to instil discipline into the manager research process by appraising critical factors that can help determine a fund’s ability to outperform. Funds are evaluated across the 5 pillars that Morningstar has identified as being helpful in predicting the future success of funds: Parent, People, Process, Performance, and Price. Parent The culture and structure of an asset management firm can have an impact on its ability to attract and retain talent and its penchant for serving in the best interests of fund shareholders. People Evaluating the depth and capabilities of an investment team is critical in attempting to identify funds that have a competitive advantage over their competition. Process Morningstar favours managers who employ a disciplined, consistent, and repeatable investment process. Ultimately, Morningstar is looking for traits that give the investment team an edge over its competition. Performance The goal is to identify management teams that in the past have demonstrated skill which we define as the ability to outperform their respective benchmark/peer group on a risk-adjusted basis in a consistent fashion. Price Research indicates that expenses are critical in predicting future fund performance. A fund’s expense ratio should be evaluated within the context of the relevant region and relative to its Morningstar peer group and also consider the trend in expenses and assets in the fund. Portfolio Construction Morningstar firmly believes that asset allocation is a primary determinant of investment returns within a global fund portfolio. Hence, an important consideration for our final selection is how the fund will complement the remainder of the portfolio or select list.

What is the Morningstar Rating for stocks?

This is the quantitative rating of the fair value of a company per share. The Morningstar analysts calculate this estimated fair value by forecasting how much free cash flow the company will generate in the future. This means the amount of cash a company still has after all its costs and investments have been paid and what is available for distribution of dividends to the shareholders of that company. This value is then adapted by taking into account time and risk. Cash generated next year is worth more than cash generated over a number of years. In the same way, cash of a stable and consistently profitable company is worth more than of a company in a strong cyclical sector. Shares that are traded at a price that is significantly lower than the fair value estimated by Morningstar, receive more stars. For high-quality companies we require a smaller undervaluation than for medium-sized companies. That is for one simple reason: Morningstar trusts more in its cash flow forecasts for strong companies and therefore also in its value estimates of such companies. If the market price of a share is considerably higher than the fair value estimated by Morningstar, that share gets relatively few stars, regardless of how great Morningstar believes the company in question to be. Even the best company is bad business if an investor pays too much for the shares. In short: 1 star for a share stands for maximum overvalued and 5 stars stands for maximum undervalued. 3 stars means a share is reasonably or fairly valued. The rate is on or near the level of the fair value given by the Morningstar share analysts to the share.

What is the quantitative Fair Value Estimate for stocks?

The fair value is the outcome of the valuation models based on the discounted cash flow and is Morningstar’s estimate of the intrinsic value or fair value of a company per share. Morningstar adapts its fair value to take into account obligations or assets a company might have that are not included in the balance sheet. For instance, Morningstar lowers the fair value of a company if it has issued too many stock options or if it has an under-financed pension scheme. Morningstar’s estimate of the fair value differs in two aspects of a target price or profit target. First of all, it is an estimate of what the company is worth, whereas a target price usually reflects what other investors might pay for the share. And secondly it is a long-term estimate, whereas profit targets are usually aimed at the next 2 to 12 months.

What is the Quantitative Economic Moat for stocks?

The concept of the ‘economic moat’ or competitiveness or competitive advantage is essential, not only in Morningstar’s qualitative determination of the attractiveness to invest in a company, but also in the valuation process. Morningstar uses three evaluations of this competitive advantage: none, narrow and wide. There are two important conditions for a company to obtain a narrow or wide evaluation of its competitiveness. First of all, the prospect of obtaining a more than average yield on capital and secondly a competitive advantage that protects and sustains this yield in the long term. Competition usually lowers the profit. But companies that are able to sustain their profit over a long period because they have been able to create a competitive advantage, have a ‘moat’. We consider these companies superior investments.

Who is Morningstar?

Morningstar, Inc. is a leading provider of independent investment research in North America, Europe, Australia, and Asia. They offer an extensive line of products and services for individuals, financial advisors and institutions. Morningstar is highly respected for their independent investment information. Their strength lies in their independent status, expert research and well tested rating and equity scoring models.

What is the Morningstar Star Rating?

The Morningstar Star Rating is derived from a quantitative method in which mutual funds are ranked on the basis of their historical returns (adjusted for risk and costs) over periods of at least three years. These “risk-adjusted returns” are based on the monthly returns of a fund, where downward variations result in a lower score and a consistently good performance is rewarded with a higher score. Another important aspect is costs, making it more difficult for relatively expensive funds to receive a high star rating. The top 10% of funds in each category receive 5 stars, the next 22.5% receive 4 stars, the next 35% receive 3 stars, the next 22.5% receive 2 stars and the bottom 10% receive 1 star. This Star Rating is calculated over periods of the past three, five and ten years. If possible, Morningstar will also calculate these ratings for all periods in its Overall Morningstar Star Rating.

What is the Morningstar Analyst Rating?

The Morningstar Analyst Rating is a qualitative assessment that is issued by Morningstar fund analysts. This rating represents a forecast on the future performance of funds relative to peers and/or relevant benchmarks. In order to issue a rating, the Morningstar fund analysts base their assessment on five pillars: investment team, investment process, performance, costs and fund house. A rating of ‘Gold’, ‘Silver’ or ‘Bronze’ is attributed to investment funds that are expected to perform better during a future full market cycle than the category and/or risk-adjusted relevant benchmarks. The difference between these ratings is determined by the degree of conviction of the fund analyst of the ability of the fund to achieve outperformance. Funds that are not expected to distinguish themselves will receive a ‘Neutral’, rating, while funds that perform below par on several levels will be assessed as ‘Negative’.

What is the SRRI rating?

The Synthetic Risk and Reward Indicator (SRRI) was defined in 2009 by the Committee of European Securities Regulators (CESR) with the aim of providing investors with a method of assessing a fund’s risk. The SRRI measures the volatility of the fund. A higher volatility means there is greater uncertainty about the size of the changes in a fund’s value. This means that the price of the fund can change dramatically over a short time period in either direction. A lower volatility means that a fund’s value is not expected to fluctuate dramatically, but to rather change in value at a steady pace over a period of time. The table below shows the mapping between the volatility and the SRRI value. The table below shows the differences in percentages that the value of a fund may experience over one year (Annualised Volatility). The percentage is linked to the respective SRRI rating. The more limited the variation is, the lower the SRRI Rating of a fund. The higher the variation, the higher the SRRI Rating. SRRI Annualised Volatility  1 0 – 0.49%  2  0.5 – 1.99% 3 2 – 4.99% 4 5 – 9.99% 5 10 – 14.99% 6 15 -24.99% 7 25% + The SRRI is calculated based on the fund returns over the last 5 years. If a fund is less than 5 years old, the returns of a comparable benchmark is used for the period before the fund was launched.