Good returns, poor stewardship.
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.
Funds that receive poor Stewardship Grades from Morningstar are Red Flags in the classic sense. The Stewardship Grades look at a fund's regulatory history, board of directors' independence, management incentives, fees, and corporate culture to determine whether long-term shareholders' best interests are put first. Funds that earn poor grades typically have had run-ins with government regulators, are overseen by boards of directors who make scant investments in the funds they govern, or are run by fund shops with high personnel turnover and sales-driven cultures.
We don't suggest that investors use the Stewardship Grades in isolation when making investment decisions. Rather, the grades are best considered alongside other measures, including the Morningstar Rating. A stronger grade at one fund could help investors decide between two mutual funds that are equally compelling from an investment-process standpoint. Similarly, a poor grade could sway an investor away from an otherwise compelling fund. It's these latter types of funds--strong performers with average-to-subpar grades--that we highlight in this edition of Red Flags.
Legg Mason Partners Aggressive Growth
When it comes to performance, this large-growth mutual fund is a proven winner. Veteran Richie Freeman is a skilled manager who unflinchingly stands behind his picks and has delivered strong relative returns in good times and bad for growth stocks. On the stewardship side, however, this fund has some notable shortfalls and earns a D Stewardship Grade.
The fund belongs to a hodgepodge family of mutual funds that were cobbled together via acquisitions and, therefore, don't operate under a single, notable investment culture, although management is trying to change that. What's more is that the fund's governance is in flux as Legg Mason Partners' fund boards are being consolidated into two boards from 10. These mergers understandably would streamline the funds' oversight, but the departing directors would receive millions in retirement and other severance benefits. And who will foot the bill for this cleanup? Fund shareholders.
All told, we think this fund's Stewardship Grade provides good reason to pass on the mutual fund.
Neuberger Berman Partners
Over in the large-blend camp, this 5-star mutual fund has been on a tear in recent years. Manager Basu Mullick is a high-conviction investor who has done well for shareholders, partly because of his bold sector bets. The fund's stewardship picture isn't as rosy, though. It earns a middling C Stewardship Grade, in part because management's own financial interests aren't well aligned with those of long-term shareholders.
For example, Mullick's pay depends in part on assets under management, which encourages managers to run larger funds even though it's often easier to deliver peer-beating returns at a smaller mutual fund. Finally, Mullick has between $100,000 and $500,000 invested here, which seems slight given his nine-year tenure.
In all, this fund's Stewardship Grade doesn't signal disaster, but there's plenty of room for improvement.
This fund's management team has consistently applied a strategy that seeks companies with past earnings disappointments that are poised for a rebound. However, management hasn't been all that clear about who's running the fund nor has it closed the fund in a timely manner. Those are key issues to the fund's future success.
For example, day-to-day manager Jamie England, who came on board in 2004, wasn't listed as a skipper on the mutual fund until recently. Finally, we're disappointed in management's compensation structure, which pays big bucks for top-decile one-year performance. Such an incentive scheme encourages managers to take on considerable risk--not deliver superior, steady returns over a longer period. In fact, that's similar to the bonus structure that led Janus funds into a big mess during the dot-com bubble.
Laura Pavlenko Lutton is an analyst with Morningstar.