(PUB) Morningstar FundInvestor

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Sometimes Our Weakest Choices Turn Into Our Best Tracking Morningstar Analyst Ratings | Russel Kinnel

I pulled out the June 2008 FundInvestor to look at what funds were Analyst Picks (the precursor of our Gold rating) but had bottom-decile five-year returns. There were five: Clipper CFIMX , Oakmark Select, Fidelity Dividend Growth FDGFX , Weitz Value WVALX , and Ariel Appreciation CAAPX . Four out of those five produced top-decile returns over the ensuing five years, and one, Clipper, was just a hair below the category median. Overall, their average performance ranking was in the top 15% for the past five years. What about the Analyst Picks that were top-decile for the past five years in June 2008 ? The results are pretty good but not as good as the hated five’s. The 15 in the top decile produced an average performance ranking of 31 . 5% in the ensuing five years. That’s still pretty good. Three of the 15 were top-decile: TCW Total Return Bond TGLMX , T. Rowe Price Global Stock PRGSX , and Oppenheimer International Growth OIGAX . However, three were bottom-decile over the next five years: Schneider Value SCMLX , Vanguard Precious Metals and Mining, and Thorn- burg Value TVAFX . Looking for more contrarian ratings plays you can make today, there’s Janus Overseas. The fund has a distinct bias toward India that has made it swing dramatically. Like Vanguard Precious Metals and Mining, it could be a good contrarian bet. FPA New Income FPNIX is another Silver-rated fund with poor five-year performance that could bounce back. The fund is run to the conservative side of non-traditional-bond funds as well as its old peer group in intermediate bond. Tom Atteberry is focused on avoiding losses. His goal is beating the Consum- er Price Index by 100 basis points a year. So, he’s not trying to make big bets on market direction. Rather, he’s trying to avoid big bets. If everything goes swim- mingly in bond land, the fund may well look humdrum, but if things hit the fan, it ought to provide solid protection. Finally, the 1 -star Silver-rated Royce Low Priced Stock RYLPX has suffered from Whitney George’s fondness of materials stocks. A rebound in the world economy could give this fund a nice snap back. œ

“How can a fund with as poor performance as Vanguard Precious Metals and Mining VGPMX earn a Gold rating?”

What Are Morningstar Analyst Ratings?

Our ratings are chosen for long- term success. Analysts assess a fund’s competitive advantages by analyzing people, process, parent, performance, and price. They do rigorous analysis and then submit their ratings to a committee that vets their work for thoroughness and consistency.

“Why do you give a Silver to Janus Overseas JAOSX despite terrible five-year returns?”

It may appear we’re oblivious to evidence refuting our ratings. I get an email along these lines every couple of days. But the emails I get today are nothing like the complaints I received about recommending Bill Nygren’s Oakmark OAKMX and Oakmark Select OAKLX a few years ago. I understand the questions, but five-year returns are not as telling as we all wish they would be. That’s particularly true for funds that have big biases rela- tive to their category peers. Vanguard Precious Metals and Mining invests in gold stocks like its peers but also in diamond, copper, and potash miners. As a result, the fund’s performance relative to its category really tells you how those industries are doing relative to gold rather than whether man- ager Graham French is doing a good job. In fact, five years ago Vanguard Precious Metals and Mining was in the top percentile for its peer group, thus illustrating my point. While this fund’s biases are a little more extreme, it’s really true of a lot of funds. A typical equity fund may have a much different sector or market-cap profile than its peers. Focused funds can rally or plum- met on just a few holdings, as funds like Oakmark Select have shown. A bond fund might have signifi- cantly lower duration or higher credit risk than most others in its category. As all of these factors go in and out of favor, a fund’s returns will bounce up and down. We try to adjust for those factors to see whether a manager is really adding value.