• / Free eNewsletters & Magazine
  • / My Account
Home>Research & Insights>Investment Insights>October 2009 Mutual Fund Red Flags

Related Content

  1. Videos
  2. Articles

October 2009 Mutual Fund Red Flags

These three funds are beseiged by outflows.

Greg Carlson, 10/13/2009

This article originally appeared in Morningstar FundInvestor, an award-winning newsletter that presents investment strategies and tracks 500 funds.

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 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.

While equities' sharp plunge ended in March 2009, its effects linger on at many funds. Mutual funds that posted particularly poor results have seen investors continue to pull out money--even if the funds have rebounded sharply in the ensuing rally.

Substantial outflows can be damaging to a fund's remaining shareholders. They can force the manager to sell large chunks of holdings, thus driving down their share prices as they sell and lowering returns. Also, those holdings may be especially undervalued at that time, so there's a missed opportunity to benefit from a rebound. Forced sales mean more portfolio turnover and thus drive up trading costs. In addition, falling assets can lead to rising expense ratios.

So this month, we're taking a closer look at a few funds that have performed poorly and have seen hefty outflows. We're focusing on funds where cash flows have not yet turned positive; rather, although outflows may not be as big as they were in the depths of the bear market, they remain steady.

Legg Mason Value LGVAX is the poster child for funds hammered by the financial crisis. (Its A shares were just launched in February, but its C shares date back to 1982.) Longtime skipper Bill Miller believed that homebuilders, mortgage lenders, and other large financial firms had been punished too harshly in 2007 and would rebound when liquidity did. So he added to his stake in many of them, only to see them get crushed. Shareholders have been pulling money out for a while now in response to the fund's struggles. Over the 12 months ended Aug. 31, 2009, they redeemed shares to the tune of $2.5 billion, more than half as much as its current $4.6 billion asset base. Withdrawals have slowed in recent months as the fund has outperformed in the rebound, but they still amounted to $55 million in August 2009. The fund invests primarily in large caps and is far smaller than it used to be--but it takes big positions in its favorites. We don't think outflows are a significant issue right now compared with the fund's continued volatility, but another bout of poor performance could mean trouble.

Another fund beaten up by the mess in the financials sector, Schneider Value SCMLX, has also bled money as a result. Big bets on mortgage lenders Fannie Mae FNM and Freddie Mac FRE, the shares of which were then crushed and rendered nearly worthless, led to a brutal 55% loss in 2008. And although the fund has come surging back in 2009, its five-year record is still quite poor. While its outflows haven't been on the scale of Legg Mason Value's (either on an absolute basis or relative to its $121 million asset base), they have been pretty steady. Over the past 12 months, outflows have totaled $45 million, or roughly 37% of the fund's current assets. Although flows have been positive in a couple of recent months, $5.5 million was pulled out in August 2009. Because this is another concentrated fund--and its portfolio includes a substantial number of mid-cap firms and even some small caps--we do have some concerns about how this might affect the fund's performance.

Transamerica Premier Equity TEQUX was hit hard in the bear market, too, but for different reasons. Manager Gary Rolle likes companies with strong competitive advantages that he believes are trading cheaply relative to their prospects, but their absolute valuations are sometimes lofty. That factor, combined with the fund's recent focus on names with heavy exposure to consumer spending trends, led to the fund's 45% loss in 2008 (which in turn has caused the fund to look average to subpar over longer periods). Shareholders have responded by pulling out in droves; nearly $273 million has left the fund over the past 12 months, which is equal to 62% of its current assets. The fund is relatively small at $440 million and outflows have slowed, so forced selling should be modest and shouldn't have a big impact on the fund's large, liquid holdings. But it does have a concentrated portfolio of just 34 stocks, and the fund has continued to struggle on a relative basis in 2009. We'd keep an eye on this large-growth fund.

Greg Carlson is a mutual fund analyst with Morningstar.

Get mutual fund and stock information from our analyst team delivered to your e-mail inbox every Tuesday. Sign up for our free Investment Insights e-newsletter.

©2017 Morningstar Advisor. All right reserved.