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March's Mutual Fund Red Flags

A second look at struggling managers.

Russel Kinnel, 03/13/2007

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.

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

When a fund gets a new manager, it's a good idea to check up on it regularly. But you really need three or more years to judge the new manager's abilities, so let's take a look at some funds that got new managers around three years ago. Specifically, let's look at those with lousy three-year track records. It's tempting to jump ship on these funds, but should you? One key thing to determine is whether the poor returns are due to inefficient execution or simply that the fund's strategy is out of favor. Second, take a look at the manager's background. On the plus side, see if the manager has contributed to the fund's past success or if he or she comes with experience at a good firm. If management lacks that experience, though, I'd be quicker to pull the trigger.

Fidelity International Small Cap FISMX
The fund has fallen back to earth pretty quickly. The fund had three great years, a manager departure, and now one lousy year. The current trio of managers came on board in 2003, 2004, and 2005. The good news is that two get credit for a strong 2004 and 2005, but all three share the blame for a dismal 2006, which was so bad that the fund's trailing three-year record is around its category's bottom quartile. The big problem was the fund's significant weighting in Japan. I'll forgive them though, because Japan was also quite a contributor in past years. However, our lead Fidelity analyst, Dan Lefkovitz, points out that the fund's portfolio has bloated from 132 stocks to 712, even though it closed in 2005. So with new management, poor returns, and asset bloat, you might consider bailing on this one.

Neuberger Berman Focus Inv NBSSX  
The fund has always taken on extremes. With a focused portfolio and heavy emphasis on technology and financials, this fund seems to come in either first or last every year. However, much of the fund's past glory is due to former manager Kent Simons, although Bob Corman took over in 2005 and doesn't have much to show for it. The fund's three-year record is abysmal. Corman had been comanager since 2003, and he has 20 years of experience at Jennison Associates before that. So I wouldn't completely write off this fund. If tech comes back, Corman might look brilliant. Even so, I wouldn't put more than 5% of a portfolio in this superspeculative investment.

TCW Select Equities I TGCEX
The fund has been a real dud since Craig Blum and Steve Burlingame took over for longtime manager Glen Bickerstaff in 2005. That year, the fund returned a mere 3.7%, and in 2006, the fund lost 5.1% even though it was a pretty good year for the market. There are some strong similarities with the Neuberger fund, and this one is also a focused fund with a big tech bet. However, it has a bias toward faster-growing stocks, so it's more risky than Neuberger. So, holding on here means you're betting that the new managers have a lot of skill and that tech will come back. Once again, I wouldn't give up on it, but I'd keep it to a very small position. Focused funds should only be entrusted to the very best managers, and Blum and Burlingame have yet to prove themselves.

Meridian Value MVALX
The fund has a poor record but, unlike the above funds, is actually showing signs of life. Jamie England took over in 2004 and suffered two weak years but then turned things around in 2006. Even so, the fund's three-year record is right around the cutoff for the bottom third of the category. England has maintained the strategy of his predecessors of searching for good companies that have suffered earnings disappointments. Initially, he bought into value traps like Eastman Kodak EK but has more recently hit upon winners like Equity Residential EQR. At this point, one good year and two bad ones hardly make for a convincing case. I'd hold off on this one.

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