Try this screen for core funds that take the road less travelled.
This article first appeared in the February/March 2011 issue of Morningstar Advisor magazine. Get your free subscription today!
Actively managed funds that don't move in lockstep with the overall market may be appropriate portfolio anchors for certain clients, while others may be more comfortable using them to complement core index offerings. These funds tend to be run by managers who don't let benchmarks guide their stock-picking or sector-weighting decisions. You can use this straightforward screen in either Morningstar Advisor Workstation or Morningstar Principia to turn up intriguing large-cap funds which have delivered compelling returns without following an index.
Special Criteria = Distinct Portfolios Only
And ( Morningstar category = Large Value
Or Morningstar category = Large Blend
Or Morningstar category = Large Growth
Or Morningstar category = Mid Value
Or Morningstar category = Mid Blend
Or Morningstar category = Mid Growth )
And Purchase Constraints = Closed-New Investment
And Min Initial Purchase < 25,000
And Analysis not = NA
To set up the screen, narrow the field to domestic large- and mid-cap funds that are open to new investments of $25,000 or less and followed by Morningstar Analysts.
And R2 3 Yr < 85
Next, set the three-year R-squared measure, which represents the percentage of a fund's performance that can be explained by movements in a benchmark index, to 85 or less. (The median R-squared for all U.S. large-cap funds clocked in at 94 for that period.) In the case of all U.S. equity funds, the S&P 500 is used as the standard index, and an R-squared of 100 indicates that the fund's performance moved in tandem with that benchmark.
And % Rank Cat 5 Yr < 33
And ManagerTenure (Longest) > 5
And Audited expense ratio < 1.25
Lastly, narrow the search to funds with top third five-year rankings and manager tenures of at least five years. The median expense ratio for broker-sold large-caps is 1.25% annually, which is the cut-off here.
Side note: This screen can be run for large-cap international equity funds, in which case it would compare those funds with the MSCI- EAFE Index.
Here are some of the resulting funds:
Longtime manager Ken Heebner's is willing to make big investments in individual positions, such as his 10% stake in Ford F, as well as sectors (the fund's 48% stake in consumer goods was over four times the S&P 500's). Heebner typically moves in and out of sectors quickly while often holding a decent chunk of assets in treasuries and corporate bonds. (Its stock/bond ratio was recently around 75/25, but its average bond allocation in the past three years wasn't high enough to move the fund to the aggressive allocation category.) So, it's not surprising to see this large-growth fund's R-squared measure was a mere 65. The manager's fast-trading style can lead to an unpredictable portfolio and lumpy performance, but long-term it has delivered the goods.
He has executed this distinctive approach effectively over time. Over the past decade the fund's 5.7% annual return is topped only by CGM Focus' 17.2% gain in the large-growth category. Volatility, though, has been on par with its typical peer's over the past five- and 10-year periods.
PRIMECAP Odyssey Aggressive Growth
They often buy small-cap firms and hang on until they grow into mid-cap territory, and |large stakes in health-care and tech- nology stocks have cropped up over the years. And at last count, about two thirds of the fund's holdings didn't reside in the index. All these factors have kept its three-year R-squared number at 84. The fund's experienced managers and their deft stock- picking have made this a tough one to beat.
Berkowitz knows that to beat the pack you have to break from it. In a flashback to the fund's early years, Berkowitz again has nearly three fourths of its equity assets in financial-services stocks-four times the category average. In 2010, he loaded up on debt and equity from a number of firms that were hit hardest in 2008's crisis, including American International Group
A disciplined emphasis on quality firms gives the fund a predictable, attractive risk/reward profile. It has experienced about 80% of the S&P 500's upside but only 50% of its downside the past decade. A manageable asset base and reasonable fees add to its appeal.
Karin Anderson is a mutual fund analyst with Morningstar.