Two passive options, an alternatives fund, and a new offering from a proven team are among the highlights.
A version of this article was originally published in the second-quarter 2017 edition of Morningstar Prospects, which highlights promising managers that Morningstar Manager Research analysts currently do not cover but may cover in the future. The full list and publication are available to subscribers of Morningstar Direct.
Morningstar Prospects--a list of up-and-coming or under-the-radar investment strategies that Morningstar Manager Research thinks might be worthy of eventual full coverage--added six new strategies in the second quarter of 2017. Here's a look at five of them.
Cheap Exposure to High-Yield Debt
Deutsche X-trackers USD High Yield Corporate Bond ETF HYLB provides market-cap-weighted exposure to U.S.-dollar-denominated high-yield bonds with a remaining maturity of between one and 15 years. It tracks the Solactive USD High Yield Corporates Total Market Index; eligible bonds must be issued by companies domiciled in developed markets. Currently, the exchange-traded fund holds bonds from the United States, Canada, Luxembourg, Netherlands, the United Kingdom, Cayman Islands, and France. U.S.-based issuers take up roughly 80% of the portfolio. These bonds must be rated as below-investment-grade by either Moody's or Standard & Poor's. Roughly half of the portfolio is allocated to BB rated securities. B rated bonds constitute about 40% of the portfolio, and the balance is mostly invested in CCC rated issues. The minimum deal size is $1 billion, with $400 million or more par outstanding. As of Sept. 30, 2016, the index comprised 1,161 bonds issued by 435 different issuers. Its fee of 0.25% is competitively priced against other high-yield passive ETFs, which charge 0.41% on average. It returned 6.57% from its December 2016 launch through July 2017, lagging the benchmark by 0.36%. The fund performed on par with its typical Morningstar Category peer for the period.
A Wide-Ranging Alts Fund
GMO SGM Major Markets GSMFX is a quantitatively driven global macro strategy. Lead manager Jason Halliwell and his team have been running this strategy since the 1990s, primarily in hedge fund vehicles. In 2011, this fund was launched as a building block for the firm's flagship fund GMO Benchmark-Free Allocation GBMFX, and in 2017 it was made more widely available. In this fund, management targets annual returns of cash plus 5% (after fees) with volatility of approximately 8% as measured by standard deviation. The strategy takes long and short positions in a variety of futures markets across equities, fixed income, currencies, and interest rates. To determine positions, the team develops long-term forecasts for each of the 31 futures markets in which the fund trades; these forecasts are largely based on valuation measures. They combine the forecasts with shorter-term momentum and sentiment factors to find markets trading out of equilibrium with their long-term forecasts. Management will short markets that appear overvalued in the short term and buy those that look undervalued. The average trade lasts three to six months. Management attempts to keep an equal exposure to long and short bets over time, so the fund should have a low correlation to traditional asset classes. GMO's investment minimums are very high, but the funds are available through some retirement plans and financial advisors.
A Passive Strategy With a Contrarian Twist
Oppenheimer Large Cap Revenue ETF RWL is an index strategy that invests in the same stocks as the S&P 500 but weights them by trailing 12-month revenue rather than market capitalization. This causes the fund to overweight stocks trading at low multiples of sales, pulling it into the large-value category. When it rebalances each quarter, the fund increases its exposure to stocks that have become cheaper relative to their sales and trims positions that have become more expensive. This contrarian rebalancing strategy could help the fund profit from mean reversion in valuations. However, it could also increase the fund's exposure to stocks with deteriorating fundamentals because market prices are faster to pick that up than backward-looking sales data. Revenue weighting also skews the portfolio toward firms with lower margins, including many consumer cyclical and consumer defensive stocks. So far, this strategy has worked well. From its inception in February 2008 through July 2017, the fund outpaced the Russell 1000 Value Index by 1.2 percentage points annually, with comparable volatility. While the fund's 0.39% expense ratio is in the ballpark of other fundamentally weighted strategies, Schwab Fundamental US Large Company IndexSFLNX offers similar exposure for less (0.25%).
A New Fund With a Proven Team and Approach
T. Rowe Price QM U.S. Small & Mid-Cap Core Equity TQSMX just launched in early 2016, but it comes with a strong pedigree--it's managed by the same team and uses many of the same quantitative stock-picking models as T. Rowe Price QM U.S. Small-Cap Growth Equity PRDSX, which has a Morningstar Analyst Rating of Silver. That fund has been run by team leader Sudhir Nanda since 2006. Nanda took the reins of this fund along with two other team members in June 2017 from another member of the team, Boyko Atanassov (who is focusing more on quant research), but the process hasn't changed. The quant models rank stocks on valuation (price/cash flow is a preferred metric for the team), earnings quality (the models look in part for excessive accruals, which can signal inflated earnings), and price momentum (which gets the least emphasis).
Unlike many quant strategies, this one has a long-term focus (portfolio turnover at T. Rowe Price QM U.S. Small-Cap Growth Equity has been in the teens and was 11% in this fund's first fiscal year). Management also limits stock-specific risk, as this fund recently held 338 stocks, and its top holding comprised just 0.6% of assets. Sector bets are also minimized versus the fund's benchmark, the Russell 2500 Index (which, like this fund, holds a mix of small- and mid-cap stocks). Finally, although this fund is quite small, it already sports a below-average expense ratio (relative to other no-load mid-cap funds) at 0.80%.
A Small but Successful Corporate-Bond Fund
With less than half a billion in assets, Western Asset Corporate Bond SIGYX represents a mere fraction of the nearly $100 billion in investment-grade corporate mandates run by Pasadena, California-based fixed-income giant Western Asset Management. The fund struggled during the financial crisis under different leadership, but since Ryan Brist took the reins in early 2010, it has delivered strong results in markets both friendly and hostile toward credit risk. Brist, who is currently Western Asset's head of global investment-grade credit, was already an experienced corporate-bond investor when he joined the firm in 2009, having overseen credit portfolios for years at Delaware Investment Advisors and Logan Circle Partners. In addition to his exemplary long-term record on this fund, his calls have contributed to the success of the firm's diversified offerings, such as Western Asset Core Plus Bond WACPX, in recent years. With the flexibility to invest up to 20% in high-yield corporates--Brist is particularly fond of so-called crossover credits on the border between investment-grade and high-yield--the fund's portfolio may appear more intrepid than some of its more-cautious peers at times, with the performance swings to match. Overall, though, Brist's determination to avoid credits headed for trouble has paid off here, making this fund an intriguing choice for corporate-bond exposure. The I shares have a $1 million minimum but are available through some retirement plans and advisors. The fund also has other share classes with lower minimums.