A few examples that help illustrate our rating process in action.
Morningstar launched Analyst Ratings last week for approximately 350 U.S. mutual funds. This new feature complements the strictly quantitative, backward-looking Morningstar Rating (otherwise known as the "star rating") with analyst evaluations designed to ferret out which funds have sustainable advantages that position them well for the future. (You can learn more about them here.)
In the interest of helping to introduce readers to the new rating system, we've decided to highlight some of the ratings in different market sectors. We're kicking off the series with three fixed-income offerings.
PIMCO Total Return Instl PTTRX
Analyst Rating: Gold
This fund's long record of category-beating returns and 5-star Morningstar Ratings didn't make it a shoo-in for Gold. Instead, this Analyst Rating is based on a careful evaluation of each of the five pillars of Process, Performance, People, Parent, and Price, scrutinized by our ratings committee. Of course, the fund scores extremely well on most of the five pillars. It boasts a well-proven process that has evolved over the years by necessity of the fund's own growth. So, too, have the talents of its manager Bill Gross, who has had to make those extremely difficult transitions as the portfolio has ballooned. And Gross is backed by a phalanx of managers and analysts with some of the sharpest skills and resumes in the business.
The fund doesn't come up completely roses on every count, though. Although PIMCO has a lot to offer investors, some share classes are pricey, even after a recent effort to reduce fees. And while this fund previously demonstrated that it can thrive despite a massive asset base (the positioning responsible for its 2011 struggles further suggests that size has yet to impede the fund's flexibility) the firm’s unwillingness to close this or any other large funds does warrant continued vigilance. On balance, though, this remains one of the best core bond funds available.
JPMorgan Strategic Income Opportunities JSOAX
Analyst Rating: Neutral
This fund has garnered tremendous investor interest and boasts some compelling features but hasn't yet demonstrated that it offers the sustainable advantages necessary to garner a recommended rating of Bronze or higher. One of a handful of relatively new offerings marketed as unconstrained and absolute-return focused, this fund falls into Morningstar's newly minted nontraditional bond category. Despite its popularity, the fund has produced only middling returns and with average volatility relative to other members of that group, which helps explain its Neutral score for Performance.
One concern in particular helps to inform the fund's Neutral ratings for both Process and People: Despite its wide-ranging mandate, the fund has leaned heavily on the high-yield market biases of its skipper, Bill Eigen. Eigen has access to vast resources of expertise in multiple market sectors across the JPMorgan Asset Management complex, but these groups are separated both geographically and organizationally from his compact Boston-based team. Meanwhile, nearly all of the fund's performance can be explained by its exposures to the high-yield market, though Eigen employs a heavy cash stake to damp volatility and maintain consistency with his absolute return mandate. As such, it's not clear that he's been willing to place more trust in the hands of his own team and comanagers, or the other JP Morgan groups stationed around the country.
John Hancock High-Yield JHHBX
Analyst Rating: Negative
This fund would likely have earned a Negative Analyst Rating even if its returns had somehow managed to compensate for its otherwise wild profile. With more than 44% in bonds rated CCC or lower, huge concentrations at the issuer and industry level, and a history of paying out some of the highest income streams of any high-yield bond fund, it has also been one of the category's most aggressive and most volatile—with historical standard deviations that nearly match those of the Standard and Poor's 500. In fact, the portfolio lost nearly 59% of its net asset value during the financial crisis, between the end of 2006 and the end of 2008, and despite two years of massive returns in 2009 and 2010, the fund is again near the bottom of the pack with a 14% loss for the year through Nov. 18, 2011. It hasn't even come close to earning back what it lost during the crisis.
Those factors clearly inform the pillars of Process and Performance. There's sufficient reason for concern about the fund's staffing, as well, even though long-time lead manager Arthur Calavritinos departed in August. He is succeeded by three comanagers who came on board in 2008 and 2009 and have declared their intent to reduce the fund's equity stake and pay more attention to risk management, yet remain true to Calavritinos' original contrarian, deep-value approach to high-yield bond investing. As Morningstar's Sarah Bush notes, however, it will take some time for the new team to prove that it can strike a better balance between risk and return. For now, that's a development best observed from the sidelines rather than inside the game.