Despite lackluster recent performance, these offerings earn high marks in our new Analyst Rating system.
One of the most frequently asked questions about the new Morningstar Analyst Ratings for funds is how they differ from our Morningstar Ratings for funds, also known as our star ratings. The short answer is that the new ratings are qualitative and meant to be forward-looking. By contrast, the star rating is strictly quantitative, providing a snapshot of how a fund has balanced risk and return in the past.
In last week's Five-Star Investor I provided a vivid depiction of the differences between the two ratings systems, highlighting several funds that, despite strong recent performance, rated a Neutral or even a Negative in our new Analyst Rating system.
The opposite phenomenon also exists: Because the new ratings are meant to be forward-looking, it's possible for funds with weak recent performance to earn ratings of Bronze, Silver, or even Gold. Even though a fund's performance is a component of our Analyst Ratings, the analysts don't fret too much if a fund with good fundamentals underperforms on a short-term basis. Instead, they put more weight on those factors that are correlated with strong future performance, including costs and stewardship. (A fund company's stewardship is distilled into a so-called parent grade within the new Analyst Rating system.)
I used our Premium Fund Screener to call attention to worthy funds that you might ignore if you were focusing strictly on the star rating to help you identify winning holdings. I searched for distinct portfolios of funds that have earned Silver or Gold ratings from the analysts, despite the fact that they only earn 1 or 2 stars. Below, I've highlighted a few of the most notable offerings.
This large-blend fund rates a Gold in our Analyst Rating system, despite earning a star rating of just 2 stars. The fund has also turned in a subpar record during managers Chris Davis' and Ken Feinberg's tenure. Yet Morningstar analyst Dan Culloton argues that Clipper is well worth sticking with, as a result of its low costs, seasoned management team, and the fact that management has used the same process to good effect on other charges. Culloton also likes Clipper's portfolio from a bottom-up basis, noting that it has a larger share of wide-moat companies than its average peer and that it also has higher average earnings and free cash flow yields.
Dodge & Cox Balanced DODBX
Like Clipper, performance at the Gold-rated Dodge & Cox Balanced has looked better in the past than it does now--hence its 2-star rating. An emphasis on stocks over bonds has held it back when bonds have rallied, and management's bias toward corporate rather than government bonds has also been a hindrance recently. That said, we think there's still a lot to like here--mainly, a deep and seasoned team plying a disciplined and time-tested process. Culloton lauds Dodge & Cox from a stewardship, or "parent," standpoint. In his most recent analysis, he points out that the fund firm's five-year manager-retention rate of 98% is among the highest in the industry.
PIMCO Emerging Local Bond PELBX
This fund also earns a Gold rating from our analysts, despite the fact that its three- and five-year returns--the performance that factors into its star rating--have been average or worse relative to those of other emerging-markets bond funds. But its 2-star rating owes far more to the fact that the fund is an outlier in the emerging-markets bond category than it does to defects in the fund’s fundamental characteristics. Whereas many emerging-markets bond funds own bonds that are denominated in U.S. dollars--including sibling PIMCO Emerging Markets Bond PEBIX--this one holds debt denominated in local currencies. Its emphasis on foreign-currency-denominated bonds has hurt recently, as the U.S. dollar has rallied. But as Morningstar analyst Michael Herbst noted in his last analysis, the fund has performed well relative to other emerging-markets bond funds that focus on local currency debt. More important, Herbst argues that the depth and breadth of PIMCO's research resources in emerging markets is a crucial competitive advantage. One caveat: Emerging-markets bond funds--especially the more volatile types that are denominated in local currencies--are best considered niche bond holdings because of their volatility.