Q & A with Stephen L. McKee

What is your fund rating system and how does it work?

I rank mutual funds and ETFs based on my proprietary C metric.  C is the risk-adjusted relative performance number.  Risk is measured by a fund’s monthly volatility.  Relative performance is a fund’s performance relative to the market.  The higher the C numbers the better.  C actually stands for comet.  Many people are aware of star ratings, but I wanted the metaphor to match reality.  Funds, like comets and unlike stars, come into and out of prominence.

This C metric is loosely based on Modern Portfolio Theory and the efficient frontier concept.  This area is the cusp of a diversified portfolio where returns are maximized and risks are minimized based on a combination of assets (stocks, bonds, cash).  It was from this work in the 1950s that the standard fixed diversified 60% stocks and 35% bond and 5% cash mix ratio was born.  This presumably was the market cap ratios at that time.  Subsequently, however, reality has been far different, if one was actually actively pursuing the efficient frontier in real time.  The truth is it shifts and morphs and occasionally inverts over the decades.  All investors know this.  There are bull markets and bear markets that range widely in returns and durations.  The key difference between this fixed and proactive rotation is that we recognize that the efficient frontier is fluid.  I account for that and measure C monthly.  We force a one to three-month hold to avoid short-term brokerage redemption charges.  We then proactively rotate with the fund leaders and avoid the laggards over the months, years, and decades as the markets wax and wane.