(PUB) Morningstar FundInvestor

September 2013

Morningstar FundInvestor

11

Funds That Whiffed on a Fat Pitch Red Flags | Shannon Zimmerman

Brandywine aims to figure out which companies will beat their next quarter’s earnings estimates by talking with store managers, doctors, and smartphone sellers to find out which products are soaring and which are failing. The problem is that thousands of sell-side analysts are doing the same thing, and that information becomes a commodity very quickly. This explains at least part of why Brandywine has failed to match expectations. Calamos Growth CVGRX This Bronze-rated large-growth fund had several factors working in its favor over the past three years. It tilted far more heavily toward growth stocks than most rivals, and its average market cap was far smaller. As with Brandywine, the fund’s above- average beta and standard deviation aligned with in- vestors’ appetite for risk. Moreover, while the fund sported a modest health-care underweighting relative to its average rival, it overweighted consumer cycli- cals—another outperforming sector in the period. Despite those winning attributes, the fund badly lagged its typical peer. In the trailing three years, its annualized gain of 12% , while decent in absolute terms, trailed the category norm by 5 . 3 percentage points and placed in the category’s 98 th percentile. The fund’s five- and 10 -year returns are also sub- par, and while its 15 -year showing remains topnotch, one of the managers responsible for that track record recently left both the fund and the firm. Royce Focus Value RYFVX This mid-blend fund should also have benefited from a below-average market cap over the past three years. Its growth tilt should have helped as well. Whatever benefit those attributes may have provided, though, it wasn’t enough to stave off a drubbing. Through the end of July, the fund’s annualized return of 7 . 2% placed in its category’s 98 th percentile. The fund’s ill-timed foray into materials stocks caused the most damage. œ Contact Shannon at shannon.zimmerman@morningstar.com

When Morningstar analysts evaluate a fund’s perform- mance, their assessments are grounded in data but ultimately reflect qualitative judgments. Analysts don’t focus on just a fund’s total returns, for instance, but on risk-adjusted results. And because analysts try to determine how repeatable a strategy is, the con- sistency of a fund’s performance patterns is also an important consideration. No strategy will succeed in every market, of course, but a fund should shine when conditions favor its approach. Occasional lapses won’t automatically torpedo a fund’s rating, but they do raise red flags that require further research. Below, we look at three domestic-equity funds that didn’t rise to the occasion. In the trailing three years, small-cap funds bested large-caps, growth outpaced value, and health-care and consumer-cyclical stocks led the way. Momentum was rewarded in the period and, in the form of volatility, so was risk: In the ag- gregate, funds with above-average beta and standard deviation outperformed milder rivals. Brandywine BRWIX A swing to momentum should have benefited Brandy- wine. Despite positioning near the market’s sweet spot, this Neutral-rated fund has placed in its catego- ry’s 99 th percentile for the past three years. The fund’s five-, 10 -, and 15 -year returns are similarly poor, and, unsurprisingly, management changes have ensued. Lead manager Bill D’Alonzo remains in place and currently works alongside Scott Gates, who joined as a manager in 2011 . Longtime coman- agers John Ragard and Ethan Steinberg came off the fund in 2012 and 2013 , respectively.

What is Red Flags? Red Flags is designed to alert you to funds’ hidden risks. Such risks can take many forms, including asset bloat, the departure of a solid manager, or a focus on an overhyped asset class. Not every fund featured in Red Flags is a sell, and in fact, some are good long-term holdings. But investors should be prepared for a potentially bumpier ride in the near future.