One holds steady, one improves, and one takes a dive.
Morningstar's fund analysts cover 2,000 mutual funds. Their full analyst reports, including Stewardship Grades, are available in Morningstar Principia Mutual Funds Advanced and Morningstar Advisor Workstation Office Edition.
With most portfolios still deep in the red over the past year, many investors may not view their funds' Stewardship Grades as a high priority. But whether investments are up or down, you still want to know if your fund is working for you.
We've recently updated Morningstar's Stewardship Grades for the funds that we closely follow at three well-known fund companies. In one case, we've noted some improvements in the way that the funds are caring for shareholders' capital, and in another case, we've been pleased to see the firm stay focused on serving shareholders well even as the firm's ownership has been in flux. Finally, we'll point to one firm whose stewardship seems to be deteriorating instead of improving.
When determining a fund's Stewardship Grade, we analyze five areas: corporate culture, fund board quality, fund manager incentives, fees, and regulatory history. Funds that earn high Stewardship Grades are backed by corporate cultures that are focused on serving shareholders well--not securing more sales of fund shares. These "A" stewards also have independent fund boards that do well for shareholders by negotiating lower fees, overseeing sensible funds, and closing funds that are growing too large to manage well. Funds that earn top grades for manager incentives have fund skippers that are paid to deliver strong long-term performance and also have made big investments in the funds they run. Finally, funds that get the best scores for fees and regulatory history have low expense ratios and no run-ins with industry regulators in recent years.
Holding Their Own
Just this week, we updated the Stewardship Grades for the Neuberger Berman funds. Funds in this family faced a crisis in September 2008 when their owner, Lehman Brothers, declared bankruptcy and bidders lined up to take control of the castoff asset-management firm. We had some concerns about whether Neuberger's new owner would preserve its distinct investor-focused culture, as Lehman had by largely leaving Neuberger alone. But we think that the funds are in good hands because nearly half of the firm is now owned by insiders who certainly have financial incentives to stick around and preserve the culture that's served investors well in the past. (The other half of the firm is still owned by Lehman Brothers, which is in the hands of the bankruptcy court.)
One casualty of the deal was Peter Sundman, CEO and president of Neuberger's mutual fund business, who left shortly after the buyout was announced, but otherwise, the management ranks have been stable. They have not strayed from their proven investment style, and the fund company's limited roster of funds plays to the managers' strengths. Thus, we've maintained the funds' B grade for the corporate-culture section of the Stewardship Grades.
For the Neuberger funds to improve their Stewardship Grades from here, we'd like the firm to revise its pay package for fund managers so that they're paid to deliver strong long-term performance for shareholders. As it stands now, the firm's description of its pay plan in the funds' Statement of Additional Information, a document filed annually with the Securities and Exchange Commission, is so vague that we can't tell whether managers are getting paid primarily for generating peer-beating returns, or whether other factors--like working with Neuberger's marketing team or helping build a bigger franchise--are bigger factors when setting the managers' annual bonus.
Movin' on Up
One fund family with improving Stewardship Grades is Invesco AIM. The AIM funds' scores have moved higher as its corporate culture has grown more investor-focused. The firm was troubled following dismal fund performance and a market-timing scandal in the early 2000s, and we've been looking for signs that the firm had shed its sales-focused, momentum-chasing culture.
Overall, we think that the firm's culture is now heading in the right direction. CEO Marty Flanagan, who joined AIM from Franklin in August 2005, has helped emphasize the firm's areas of strength, which include some of its international growth and core domestic funds. He also brought in new leadership where the firm has had trouble getting traction, including its domestic growth funds. Shareholder communication is improved, and the firm's sales staff seems less set on pushing hot funds and more geared toward sensible portfolio diversification.
To be sure, AIM Invesco still has plenty of room for additional improvement. Its funds' corporate-culture grade improved to a C from a D in recent months, but we'd need to see further evidence that the firm's efforts to improve its research and portfolio management are bearing fruit before we'd raise the funds' corporate-culture grade further. There are additional areas that also fall short of perfect, including manager ownership of fund shares and regulatory history.
The third firm we've re-examined recently is Putnam Investments, which--like AIM Invesco--has had its share of drama since the early 2000s' bear market set in. Many of the firm's funds that sold well in the late-1990s' bull market sustained steep losses when the tech bubble burst. Then some of the firm's investment personnel, including fund managers, were accused by regulators of market-timing the offerings they ran. These circumstances led to a wholesale change of Putnam's senior management, and frankly, we were hopeful that former CEO Ed Haldeman, who took over after the scandal broke, would be able to reform Putnam by building an investor-focused corporate culture and subduing the firm's go-go sales culture.
Haldeman and his team did make noteworthy improvements at Putnam on the ethical front. But poor performance at key, widely held offerings and continual manager turnover squashed his efforts at broader reform. In mid-2008, Putnam hired a new chief, Bob Reynolds, a former executive at crosstown rival Fidelity. Reynolds has a big hill to climb at Putnam, and he's been quick to make changes, pushing out the firm's chief investment officer, firing a dozen fund managers, and hiring some experienced managers, most of whom have Fidelity listed on their resumes.
We appreciate Reynolds' efforts to quickly clean house, but we're troubled by a few things. First, Putnam has launched a large number of new funds, which seems odd because the firm hasn't done a good job running many of the existing core funds in its lineup. Most of the new funds will be difficult for investors to use well, including sector funds. Meanwhile, Putnam's new Absolute Return funds, which aim to outperform normalized U.S. Treasuries' returns by 3, 5, or 7 percentage points per year, look like they were designed primarily to attract spooked fund investors seeking predictable returns. Putnam hasn't run funds like these before, so it's unclear whether the management team will be able to deliver on the funds' goals. We think that the new funds are a sign that Putnam's sales-driven culture is alive and well.
So much has changed at Putnam in recent years that it's difficult to predict whether their funds will be good stewards of capital. Funds in this family earn F's for the corporate-culture section of the Stewardship Grades.
Laura Pavlenko Lutton is a senior analyst with Morningstar.
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