A recent profile in Barron’s features the Morgan Stanley Institutional Growth Fund (MSEGX, Class A retail shares). This $3.5 billion fund has a maximum 5.25% front load, 0.96% expense ratio and 31% turnover. The fund can invest up to 25% of assets in foreign securities. According to the article

The fund is up an average of 10.3% a year over the past decade, better than 94% if its large growth peers.

The primary benchmark for the Morgan Stanley Institutional Growth is the Russell 1000® Growth index. An accessible implementation of this index is the iShares Russell 1000 Growth ETF (IWF). Alpholio™’s calculations show that since mid-2004 (when the current management took over), the fund outperformed the ETF in about 61% of all rolling 12-month periods.

On an annualized basis, the fund returned more than the ETF in the past three-, five- and ten-year periods. However, the fund’s Sharpe ratio was below that of the ETF in the first two periods and just slightly higher in the third one. This was due to the fund’s higher standard deviation (volatility) compared to that of the ETF. (For example, in 2008 the fund lost over 50%, while the ETF about 38%.) As a result, the stated index may not be the most applicable benchmark for the fund.

Let’s take a look at the fund’s performance through the lens of Alpholio™’s methodology, which more accurately adjusts for risk. Here is a chart of the cumulative RealAlpha™ for the fund:

Cumulative RealAlpha™ for MSEGX

In the past ten years, the general trend of cumulative RealAlpha™ for the fund has been negative. As a result, the fund generated about negative 3.6% and negative 2.6% of annualized discounted regular and lag RealAlpha™, respectively (to learn more about the regular and lag RealAlpha™, please consult our FAQ). The fund’s annualized standard deviation was about 19.2%, approximately one percent higher than that of its reference ETF portfolio. The RealBeta™ of about 1.19 underscored the elevated volatility of the fund.

The following chart shows changes of ETF weights in the reference portfolio for the fund in the same analysis period:

Reference Weights for MSEGX

The fund had top equivalent positions in the PowerShares QQQ™ ETF (QQQ; average weight of about 48.8%), iShares Morningstar Mid-Cap Growth ETF (JKH; 29.8%), Vanguard Materials ETF (VAW; 10.3%), iShares MSCI Hong Kong ETF (EWH; 5.7%), SPDR® Dow Jones® REIT ETF (RWR; 3.9%), and iShares MSCI Taiwan ETF (EWT; 1.5%). Since collectively these six ETFs were sufficient to explain the returns of the fund, the Other component in the chart was nil.

The above analysis clearly revealed that the fund’s investments were dominated by the technology sector as well as mid-cap securities. The former was responsible for the increased standard deviation of the fund. Eight of the fund’s top-ten holdings (which together accounted for 48% of assets) are traded on Nasdaq and are members of the index underlying the QQQ ETF. Therefore, the Nasdaq-100 Index®, and its QQQ implementation, would be a better benchmark for the fund. Alpholio™’s calculations indicate that the fund returned more than that ETF in only about 56% of all rolling 12-month periods since mid-2004.

Over the past ten years, the Morgan Stanley Institutional Growth Fund exhibited an unimpressive performance when truly adjusted for risk. The recovery in the fund’s cumulative RealAlpha™ that began in the second quarter of 2013 turned out to be short-lived. Investors should also be mindful of the fund’s heavy orientation toward technology stocks, which makes it more a sector rather than core large-cap growth holding in the overall portfolio. The fund could easily be substituted with a dynamic combination of just six ETFs with superior return and risk results. Finally, the fund’s substantial sales charge does not add to its appeal.

To learn more about the Morgan Stanley Institutional Growth and other mutual funds, please register on our website.


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