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August's Mutual Fund Red Flags

Manager changes at these two funds could be cause for concern. 

Morningstar Analysts, 08/22/2006

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.

If the fund you own gets a new manager, sometimes it's worth sitting tight. That's especially true if the manager inheriting your fund has an established track record and plans on maintaining the strategy of a successful predecessor. But if a newcomer with an unclear or unproven approach takes the reins, then it could be time to reconsider your investment. This month, we take a look at two recent examples of funds that may deserve the hook.

Our third Red Flag isn't about a manager departure--yet. But we've spotted one sign that veteran manager Andy Pilara might be scaling back his commitment to RS Investment Management.

Fidelity New Millennium FMILX
In July, former manager Neal Miller left this long-closed fund, reportedly staying at Fidelity in an advisory role. In his 13-year tenure, Miller delivered exceptional results, employing a highly distinctive strategy. Despite the occasional misfire, he usually was able to spot trends before everyone else (he started buying Internet names in 1995, for example).

Miller's successor, seven-year Fidelity veteran John Roth, will be hard pressed to match Miller's strategy, so look for this fund to become a more traditional growth fund. At this point, we can't be certain exactly what form that will take. Roth's experience, which includes stints at value-oriented Fidelity Select Chemicals FSCHX and growth-leaning Fidelity Select Multimedia FBMPX, is broad. He also has the benefit of a small asset base and moderate costs. But with brief records at his sector-focused charges, it's difficult to assess his talents.

If you own the fund, keep a close eye on what portfolio and strategy changes take place over the coming year.

American Century Select TWCIX
After former manager John Sykora stepped down in May, American Century brought aboard Harold Bradley as his replacement. That marked a big shift in strategy from mild mannered to aggressive.

Sykora emphasized steady firms with high returns on capital and solid balance sheets. By contrast, Bradley has run other funds using aggressive quantitative models that favor stocks with accelerating growth and strong price momentum. Those models have led to sky-high turnover and volatile performance at his other funds. He has toned down his models a bit to reflect this fund's conservative leanings, but investors shouldn't be surprised if it courts more valuation and sector risk than before.

Bradley is a good manager, but you ought to evaluate whether his bold style is what you want out of this fund.

RS Partners RSPFX, RS Value RSVAX, RS Global Natural Resources RSNRX
We're big fans of Andy Pilara's broad-minded approach to value investing. However, he has been selling his funds.

At the end of 2004, Pilara had more than $1 million invested in RS Partners and RS Global Natural Resources, with an additional $500,000 to $1 million in RS Value. But new filings show that by the end of 2005, he had reduced his holdings in Partners and Natural Resources to the $500,000 to $1 million range. RS also says that for financial planning reasons he sold a larger chunk of his stake in the firm than other RS managers when it recently agreed to sell 65% of the company to Guardian Life.

To be sure, Pilara still boasts a substantial commitment to his funds and to RS as a whole. RS also has a solid bench of talent to take his place when he leaves. We wouldn't panic, but we're watching these funds closely.

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