Why some funds with lousy five-year records still have Gold ratings for now.
If you only look at recent past performance, some of Morningstar's Analyst Ratings don't add up. There are a handful of Gold-rated funds whose trailing five-year returns rank in the bottom fourth of their respective categories.
That's because our Analyst Ratings are based on more than performance. A fund's performance is only one of the five pillars of the Analyst Rating. In many cases, the other rating pillars--People, Process, Parent, and Price--can be more indicative of a fund's long-term prospects than past performance. They can, for example, help investors determine whether a fund is as bad or good as its past record suggests. A fund's Analyst Rating could change at any time, but here's a look at why some funds in the midst of five-year slumps still had Gold ratings as of mid-July 2012.
Been There, Done That
Longleaf Partners LLPFX, which trailed 88% of its large-blend peers and the S&P 500 by more than 3 percentage points with a 3.8% loss for the five-year period ending July 13, 2012, has been here before and likely will be here again. Several times in its 25-year history it has lagged its peers and the broader stock market due to deeply contrarian positions. Two of the culprits this time are Chesapeake Energy CHK and long-suffering Dell DELL. Longleaf, however, remains an intensely independent firm whose veteran managers have a long history of success with a consistent, albeit sometimes hard to watch, brand of value investing. From April 8, 1987, to July 13, 2012, the fund gained nearly 1,200% cumulatively, versus 500% for the average large-blend fund and about 730% for S&P 500 Index. The fund's high marks for its people, parent, uncompromising process, and still-strong long-term returns outweigh the recent struggles.
A simple, well-executed idea explains our high regard for DFA US Small Cap Value DFSVX despite its current ranking behind 78% of its small-value peers for the five-year period through July 13. The fund bases its passive approach on academic research that shows small-cap and value stocks tend to outperform over time. It tracks a section of the market--any stock smaller than the market's 1,000th largest with low book value/price ratios--rather than an index. That gives the fund the flexibility to trade when it is most advantageous rather than during benchmark rebalancings, which can distort share prices. It also infuses the fund with a purer shot of small-value stocks, including micro-caps, than most peers, while making it more volatile than most, too. Bearish markets, such as in 2007, 2008, and 2011, can weigh on this fund's results temporarily, but over time its low costs and laserlike focus will help it deliver what it promises.
Regrets, They've Had a Few
Things have not gone in Davis Selected Advisors' favor in recent years. The firm's three most prominent funds--the broker-sold Davis New York Venture NYVTX, no-load Selected American SLADX, and focused Clipper CFIMX--got caught with big helpings of AIG AIG and Merrill Lynch during the financial crisis and then turned in mixed results after a smart 2009 rebound due in part to disappointing picks, such as Hewlett Packard HPQ and Sino-Forest. This is the longest performance drought in managers Chris Davis and Ken Feinberg's roughly 15 years together at New York Venture and Selected American, which also have had to contend with significant outflows in recent years. The funds face challenges, but Davis and Feinberg have longer tenures than more than 95% of large-blend fund managers, charge low fees, invest millions alongside their shareholders, and adhere to the same bottom-up, low-turnover approach that has delivered index- and peer-beating results over their careers.
Proved its Mettle
Vanguard Precious Metals and Mining VGPMX hasn't been itself recently either. Though volatile in absolute terms, the fund has been known for being less variable and more broadly diversified across commodities as well as individual stocks than the typical equity precious-metals fund. The fund has been hit in recent years with a double-whammy of gold mining shares lagging the price of gold and generally lower commodity prices since 2007. Nevertheless, manager Graham French has been at this longer than more than 80% of his peers and has the lowest expense hurdle to clear. He also was named one of Morningstar Europe's 2011 fund managers of the year for his work on another overseas fund. It's still the best of a volatile lot in the equity precious metals category.
Bogle Small Cap Growth Institutional BOGIX suffered like a lot of quantitative strategies in 2007 and 2008. But veteran manager John Bogle Jr. avoided the temptation to completely overhaul his computer models, opting instead for tweaks that pay closer attention to short-term volatility signals and could tip the fund off to trading opportunities. Essentially, the fund still relies on the same valuation and earnings momentum models responsible for its strong long-term record. Though the fund's five-year returns still trailed more than 80% of its peers on July 13, performance has improved since 2008.
Big helpings of financials and corporate bonds during the financial crisis ravaged what had been up to then Dodge & Cox Balanced's DODBX remarkably consistent record. A nearly 75% equity stake and a short-duration, mostly corporate bond portfolio has made for somewhat erratic returns since. However, the fund still has one of the deepest and most experienced crews of value-oriented stock and bond managers in the business and a low expense ratio. Its huge equity stake, which the managers contend is justified given the low bond yields and reasonably priced stocks they're seeing, will make the fund more volatile than it's been in the past. However, it's still capable of delivering superior returns over the long term.