(By Dan Culloton) If you only look at recent past performance,
some of Morningstar's Analyst Ratings don't add up. There are a handful
of Gold-rated funds whose trailing five-year returns rank in the bottom
fourth of their respective categories.
That's because our Analyst Ratings are based on more than
performance. A fund's performance is only one of the five pillars of the
Analyst Rating. In many cases, the other rating pillars--People,
Process, Parent, and Price--can be more indicative of a fund's long-term
prospects than past performance. They can, for example, help investors
determine whether a fund is as bad or good as its past record suggests. A
fund's Analyst Rating could change at any time, but here's a look at
why some funds in the midst of five-year slumps still had Gold ratings
as of mid-July 2012.
Been There, Done That
Longleaf Partners(LLPFX),
which trailed 88% of its large-blend peers and the S&P 500 by more
than 3 percentage points with a 3.8% loss for the five-year period
ending July 13, 2012, has been here before and likely will be here
again. Several times in its 25-year history it has lagged its peers and
the broader stock market due to deeply contrarian positions. Two of the
culprits this time are Chesapeake Energy(CHK) and long-suffering Dell(DELL).
Longleaf, however, remains an intensely independent firm whose veteran
managers have a long history of success with a consistent, albeit
sometimes hard to watch, brand of value investing. From April 8, 1987,
to July 13, 2012, the fund gained nearly 1,200% cumulatively, versus
500% for the average large-blend fund and about 730% for S&P 500
Index. The fund's high marks for its people, parent, uncompromising
process, and still-strong long-term returns outweigh the recent
struggles.
It's Academic
A simple, well-executed idea explains our high regard for DFA US Small Cap Value(DFSVX)
despite its current ranking behind 78% of its small-value peers for
the five-year period through July 13. The fund bases its passive
approach on academic research that shows small-cap and value stocks tend
to outperform over time. It tracks a section of the market--any stock
smaller than the market's 1,000th largest with low book value/price
ratios--rather than an index. That gives the fund the flexibility to
trade when it is most advantageous rather than during benchmark
rebalancings, which can distort share prices. It also infuses the fund
with a purer shot of small-value stocks, including micro-caps, than most
peers, while making it more volatile than most, too. Bearish markets,
such as in 2007, 2008, and 2011, can weigh on this fund's results
temporarily, but over time its low costs and laserlike focus will help
it deliver what it promises.
Regrets, They've Had a Few
Things have not gone in Davis Selected Advisors' favor in recent years. The firm's three most prominent funds--the broker-sold Davis New York Venture(NYVTX), no-load Selected American(SLADX), and focused Clipper(CFIMX)--got caught with big helpings of AIG(AIG)
and Merrill Lynch during the financial crisis and then turned in mixed
results after a smart 2009 rebound due in part to disappointing picks,
such as Hewlett Packard(HPQ)
and Sino-Forest. This is the longest performance drought in managers
Chris Davis and Ken Feinberg's roughly 15 years together at New York
Venture and Selected American, which also have had to contend with
significant outflows in recent years. The funds face challenges, but
Davis and Feinberg have longer tenures than more than 95% of large-blend
fund managers, charge low fees, invest millions alongside their
shareholders, and adhere to the same bottom-up, low-turnover approach
that has delivered index- and peer-beating results over their careers.
Proved its Mettle
Vanguard Precious Metals and Mining(VGPMX)
hasn't been itself recently either. Though volatile in absolute terms,
the fund has been known for being less variable and more broadly
diversified across commodities as well as individual stocks than the
typical equity precious-metals fund. The fund has been hit in recent
years with a double-whammy of gold mining shares lagging the price of
gold and generally lower commodity prices since 2007. Nevertheless,
manager Graham French has been at this longer than more than 80% of his
peers and has the lowest expense hurdle to clear. He also was named one
of Morningstar Europe's 2011 fund managers of the year for his work on another overseas fund. It's still the best of a volatile lot in the equity precious metals category.
Quantifiable Improvement
Bogle Small Cap Growth Institutional(BOGIX)
suffered like a lot of quantitative strategies in 2007 and 2008. But
veteran manager John Bogle Jr. avoided the temptation to completely
overhaul his computer models, opting instead for tweaks that pay closer
attention to short-term volatility signals and could tip the fund off to
trading opportunities. Essentially, the fund still relies on the same
valuation and earnings momentum models responsible for its strong
long-term record. Though the fund's five-year returns still trailed more
than 80% of its peers on July 13, performance has improved since 2008.
Finding Equilibrium
Big helpings of financials and corporate bonds during the financial crisis ravaged what had been up to then Dodge & Cox Balanced's (DODBX)
remarkably consistent record. A nearly 75% equity stake and a
short-duration, mostly corporate bond portfolio has made for somewhat
erratic returns since. However, the fund still has one of the deepest
and most experienced crews of value-oriented stock and bond managers in
the business and a low expense ratio. Its huge equity stake, which the
managers contend is justified given the low bond yields and reasonably
priced stocks they're seeing, will make the fund more volatile than it's
been in the past. However, it's still capable of delivering superior
returns over the long term.
Dan Culloton is an associate director of fund analysis for Morningstar and editor of Morningstar's Vanguard Fund Family Report, a monthly newsletter that offers independent, no-holds-barred guidance on the pros and cons of this dominant fund family.