Return to Article Directory Return to Mutual Fund Article Directory According to Morningstar, there are 136 equity-income funds. Choosing which of them is best for Mrs. Flanigan -- that is, separating the wheat from the chaff -- is a question of performance and service. Performance encompasses noloads, consistent historical return, consistent portfolio management, consistent objective and investing style, competitive expenses, and full disclosure of investing methodology. Service encompasses quick turnaround in answering clients' questions, timely and accurate statements, accessibility of decision makers, and dissemination of investment philosophy and other pertinent information. Using these criteria to analyze the 136 equity-income funds Morningstar follows will give you a good idea of which funds to recommend for Mrs. Flanigan. Now let's look in greater detail at the various factors that go into your decision-making process, beginning with those that make up performance. Because so much of a fund's total return depends on the decisions of the portfolio manager, it becomes risky to hold a fund that has a new manager. No-loads: Never pay for something you can get free. Of the 136 funds, 46 have loads. That leaves 90 for further analysis. Consistent historical return: Using the "Performance Quintile Within Objective" criteria in Morningstar eliminates funds that have been ranked in the last quintile over the past three years. While past performance is not an indication of future results, why invest in those under-performers? The average equity-income fund returned 12.54 percent over the past three years, compared with 9.56 percent per year for those in the last quintile, a difference of $1,103 on a $10,000 investment over three years. That leaves 80 funds. Consistency of portfolio management: Because so much of a fund's total return depends on the decisions of the portfolio manager, it becomes risky to hold a fund that has a new manager (three years or less), unless he or she has prior portfolio management experience with another fund. This criterion eliminates another 32 funds, leaving 48. Consistency of objective in investing style: You are recommending a fund because it promises to deliver a particular objective and asset class that is right for your client. The last thing you need is for your large-cap equity income fund to start investing like your growth small-cap or international fund, which would cause chaos with your asset allocation strategy and your client's financial plan.. Eliminating those funds whose median market capitalization is less than $5 billion or whose foreign stocks comprise more than 20 percent of the portfolio leaves us with 39 funds to consider. Competitive total expense: Every dollar a fund spends on fancy offices, expensive softdollar research, and directors' perks comes out of your client's pocket one way or another. I consider a total expense greater than 1.20 percent to be excessive. In the Money &nbs;p magazine study showing the growth of two hypothetical portfolios over 10 years, one portfolio invested in funds with high total expenses (average 2.17 percent), and the other invested in low total expense funds (average 0.97 percent). The low-total-expense portfolio outperformed the high-total-expense portfolio by an average of 2 percent per year! If a 1.20 percent total expense cutoff is used, it eliminates another 20 funds, leaving 19. Full disclosure of investment philosophy: Any fund that relies wholly on a black box computer model or won't reveal how it invests on the grounds that it is proprietary trading information is asking for a lot of trust. Although these approaches (letting a magical formula do the work) can be comforting, they are not prudent from a fiduciary point of view. This criterion does not eliminate any funds. The service a fund provides to you and your clients is almost as important as performance. What good is performance if you can never get the investment company on the phone or if you can't find out what your client's average cost basis is? Service qualities are less quantifiable than the performance criteria, but as with chocolate cake, you know a good one when you taste it. The following elements determine a fund's level of service. Determine a fund's level of service: Quick turnaround in answering questions: Ours is a service business. Don't stand for rude reps, sloppy phone connections, or people with an attitude problem. You are the customer, so demand better. Of the six funds Ameristock considers its direct competitors, three require at least five business days after each month to answer the question, "What was your total return last month?" That's unacceptable. Timely and accurate statements: Thanks to advances in database and computer technology, almost everyone in our industry now provides timely and accurate statements. The hurdle here then becomes which fund group provides readable statements, combines all accounts into one statement, and can be accessed using the brokerage networks for easy analyses and presentation. Accessibility of decision-makers: A fund's researchers and portfolio managers should be available to answer your questions and enable you to become familiar with them. If you are not comfortable about the people behind each fund, how can you sound convincing to your clients? Get to know the decision-makers' e-mail addresses, meet with them at industry conferences, or call them. Even Sir John Templeton still meets with his firm's largest producers. Full dissemination of investment philosophy and other pertinent information: With more than 5,000 funds competing for your attention and instantaneous communication available via the Internet's World Wide Web, there is no excuse for a fund to withhold information. Ameristock's NAV is published daily on the Web even before the next day's papers come out. The more you know about a fund the more comfortable you and your clients will be when market corrections occur. This also will help your clients' financial plans because they will have less inclination to jump from one hot fund to the next. After we use the performance criteria to sift through the 136 equity-income funds that Morningstar follows, we were left with only 19. After further screening for service, you should have only a handful of qualified funds that you feel are worth recommending. This process should be repeated for each asset category: growth small-cap, international, and fixed-income. It will help you to become a better financial advisor, and your clients will reap the rewards. Nicholas Gerber, manages Ameristock Mutual Fund, a no-load fund based in San Francisco.