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There's Less Than Meets the Eye for These Funds

Four funds whose Morningstar Analyst Ratings are worse than their star ratings.

Janet Yang, CFA, 04/19/2012

Morningstar's recently launched, forward-looking Morningstar Analyst Ratings generally correlate with their respective backward-looking Morningstar Ratings for funds (commonly known as the star rating), though there are exceptions.

Especially for investors used to screening based on stars, a seemingly conflicting Analyst Rating should serve as a warning to dig deeper into reasons the future may not be as rosy as the past.

Within the Morningstar FundInvestor 500, there are currently two 5-star funds rated as Neutral by Morningstar analysts, seven 4-star Neutral funds, and no Negative-rated funds.

The four funds below illustrate some of the pitfalls of screening on stars alone. (The other 5-star Neutral fund was Meridian Growth MERDX, and the other 4-star Neutral funds were Fidelity Blue Chip Growth FBGRX, Janus Twenty JAVLX, Royce Value Plus RYVPX, and T. Rowe Price New Asia PRASX.)

T. Rowe Price Growth Stock PRGFX
A late 2007 manager change on this fund illustrates one of the classic instances when screening on star performance may fall short of telling the whole story.

Portfolio manager Robert Bartolo has been managing this fund since only then, so the majority of its 4-star rating was achieved under the previous manager, Robert Smith, who managed the fund from 1997 to 2007. Bartolo had a hard time out of the gates in 2007 and 2008 (years that also coincided with some of the most difficult market environments of the past decade). He's done better in the ensuing recovery, but we'd need a longer record that demonstrates his stock-picking skill before recommending this fund.

Permanent Portfolio PRPFX
With five-, 10-, and 15-year returns that beat the vast majority of its conservative-allocation peers, investors may find the Neutral rating on this fund to be rather surprising. A look at the fund's underlying components, though, reveal some of our concerns. First, with a combined allocation of almost 70% to gold, silver, Swiss franc assets, and U.S. Treasuries, this fund resembles very few (if any) of the other funds in its group. That idiosyncratic allocation alone should cause investors to question whether, in this case, the fund's performance versus peers (and resultant star rating) fairly reflects its potential. In a market where short-term interest rates are near 0% and the Fed continues to support a particularly loose monetary policy, this fund has enjoyed huge tailwinds from its Treasury and precious-metals stakes in particular.

Those tailwinds have also masked some lackluster active management. Portfolio manager Michael Cuggino's other charges, such as large-growth Permanent Portfolio Aggressive Growth PAGRX and short-term bond Permanent Portfolio Versatile Bond PRVBX, are proxies for some of this fund's underlying components, and those have fallen short of their respective peers. The firm's sparse research resources--Cuggino and a single analyst covering six diverse asset classes--also don't help the fund's case.

Janet Yang is a fund analyst with Morningstar.

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