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July 2009 Mutual Fund Red Flags

Here's a look at three manager downgrades.

Greg Carlson, 07/14/2009

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.

This month, we're taking a look at the recent changes at the top of the funds in the Morningstar 500. When new managers come on board, they're often not as experienced as those they replace. That doesn't necessarily make a fund a sell, but greener skippers can be more timid about deviating from their category's norm (and thus are less likely to stand out), and their lack of a track record investing in a dicey area can be worrying. Here are three funds we're concerned about, to varying degrees, following manager changes.

Fidelity Small Cap Stock FSLCX
Paul Antico, this fund's only manager since its March 1998 inception, left Fidelity in June 2008 and was replaced by Andy Sassine. Antico plied a valuationsensitive approach, and although he made big sector bets at times, his sensitivity to price and financial risk kept the fund afloat when times were tough. The fund beat out 80% of its small-blend rivals on his watch. And as the longest-tenured manager running a pure small-cap fund at Fidelity, Antico was an important figure who played a key role in the development of the firm's small-cap analysts.

Sassine is different, in many ways. Rather than working on the firm's U.S. small-cap team, he served as a high-yield debt analyst and managed Fidelity International Small Cap Opportunities FSCOX to a so-so record over three years. Furthermore, upon taking over this fund, he added a passel of commoditysensitive companies to the portfolio, only to see their prices plunge. He has since shifted gears, adding a number of beaten-down financial firms that have since soared in the rebound, but we're not comfortable recommending the fund.

American Century Ultra TWCUX
A recent manager departure at this fund was hardly the first, but it may have been the most disappointing. Comanager Steve Lurito, who had joined American Century in 2007 as the chief investment officer for its growth funds, left in April 2009. We'd hoped that Lurito could turn around performance and help slow the rate of personnel turnover at the firm. His exit came on the heels of that of lead manager Tom Telford, who lasted from June 2006 to December 2008. Three other managers left the fund in 2007.

Keith Lee and Michael Li stepped in when Telford left. They have a solid record at another large-growth fund, American Century Select TWCIX, but they've only had control of that fund for just under three years. What's more, the dizzying pace of personnel turnover at American Century and the change at the CIO level raise more uncertainty here.

T. Rowe Price Latin America PRLAX
This is a case where a switch at the top shouldn't hurt the fund too much, but it detracts from the appeal of a fund that was the strongest in its category. At the end of December 2008, Jose Costa Buck took over from Gonzalo Pangaro, who has taken the reins at T. Rowe Price Emerging Markets Stock PRMSX. Pangaro had run the fund for five years and steered it to superb results over that span. Buck does have plenty of experience; as an analyst, he had worked closely with the previous managers of this fund since 2000, but he hasn't run a fund before.

Furthermore, he'll maintain the focus on reasonably priced blue-chip firms in this quite volatile region that Pangaro (with whom he'll be able to consult) had. Finally, as with most T. Rowe Price manager transitions, this one was planned well in advance, allowing Buck to prepare for this role. But his lack of a track record in a region where stock prices can quickly go into free-fall makes us a bit wary, so the fund is no longer an Analyst Pick in its category. That said, given the resources at Buck's disposal, as well as the fund's sensible approach, we still think this is one of the better options in this wild-and-woolly category.

Greg Carlson is a mutual fund analyst with Morningstar.

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