Sometimes the most basic factors can make a major difference in your analysis. The minimum Track Record filter in Klein’s K⁴ Fund Selection and K⁴ Manager Selection is a prime example. By properly utilizing it, you can reduce the number of candidates and you can also make the analysis more meaningful. It’s a simple process, but many users overlook it.

The minimum Track Record filter is unique in one sense: It’s one of the few filters in K⁴ that appears before the preference exercise and fund rankings. The Track Record filter appears in the Category Selection rather than at the end of the process like most other filter options. Users may be too focused on picking the right product type and asset type, or maybe they like the prospect of considering all of the funds or managers in the category. For whatever reason, they frequently just accept the default which is "all track records."

But you must keep in mind that when you select "all" for track record, you get all funds, including those funds started last week or last year. This can be appropriate in some instances, but it can be a poor choice that skews the results of your analysis in many others.

For example, when you analyze funds or managers, do you only use attributes based on the shortest measuring periods? Do you only look at 1-year returns? Probably not. Do you consider alpha, beta, standard deviation or Sharpe Ratio? If so, you need at least three years history to use these factors in K⁴. Candidates that haven’t been around long enough to have a value for these periods may be market leaders during their short lifespans, but that won’t come out in your analysis. They will receive zero points for each category in which they don’t have a value, so they will naturally fall towards the bottom of your results. In addition, all those funds sitting at the bottom of the rankings will make the others look better – probably too much better.

For example, using June 30, 2007 data and requiring a minimum 5-year track record, there are 972 funds in a Large Cap Growth scenario. Obviously, the fund at the bottom — the one in the last percentile — will be ranked number 972. But if you include all funds in the category and the scenario is based on 5-year Return vs. Category, 5-year R² to Category Index, 5-year Down Market Ratio, 5-year Information Ratio, and Rolling Batting Average (1 in 5), that fund suddenly rises to the 63^rd percentile. Although the fund’s actual results haven’t changed at all and that is still not a sterling result, it certainly looks a lot better.

The same thing is happening for all those funds above it, too. This can have an unexpected and undesirable effect on your investment decision process. Suppose you would only consider using the funds in the top 20% of your analysis. With 972 funds, you’d have 194 to choose from. But suppose you used "all funds." The 560 funds in this category that do not have 5-year track records will be included in your analysis even though they all sit at the bottom of your rankings and are actually irrelevant. In this case, you could go all the way down to number 306 for your top 20%; and by the way, that last fund is really in the 31^st percentile of those with 5-year track records.

So something as simple as the minimum track record can truly have a major impact on your analysis as well as your resulting investment decisions. When creating your next scenario, determine what the longest term attributes will be and match the minimum track record accordingly. That way you’ll know that each candidate will receive a rating for every factor and your results will be a true ranking of the appropriate alternatives.