Use this screen to find broad portfolios that have outperformed their peers.
This article originally appeared in the February/March 2013 issue of MorningstarAdvisor magazine. To subscribe, please call 1-800-384-4000.
If you regularly read articles written by Morningstar’s experts, you’ve no doubt read discussions of the importance of diversification in managing portfolios. Holding too many assets in one particular area of the market can have disastrous effects, especially if your client’s asset allocation is not in sync with his or her capacity for risk.
When it comes to stock mutual funds, however, some investors might assume that concentrated is better. Some of the fund world’s biggest stars—from Bill Nygren of Oakmark OAKMX to Bruce Berkowitz of Fairholme FAIRX—have managed notably concentrated portfolios. Moreover, investors might view concentration as a sign of truly active management, whereas sprawling portfolios with hundreds of stocks might have difficulty distinguishing their performance from that of a broad market benchmark.
Morningstar Category = Domestic Stock
And Special Criteria does not = Index Funds
And Total Number of Holdings >= 250
And Morningstar Rating >= 4 Stars
First, we’ll screen for domestic-stock funds with at least 250 holdings and Morningstar ratings of 4 or 5 stars. We screened out index funds so as to include only actively managed funds.
And Morningstar Analyst Rating >= Bronze
Next, we want to stick with funds rated Bronze or better by Morningstar’s fund analyst team to ensure that fund managers have been vetted.
And Total Assets $MM >= 500
And Special Criterial = Distinct portfolios only
Finally, we want funds with at least $500 million in assets, and we want to see only distinct portfolios. We performed this screen in Morningstar Principia in January. Thirteen funds made the cut. Below are a few funds on the list.
Columbia Acorn Z ACRNX
This fund’s biggest advantages are managers Chuck McQuaid and Rob Mohn, and their team. McQuaid and Mohn have been aboard since 1979 and 1992, respectively. A large, seasoned crew of analysts who are incentivized to follow a single sector for their career backs the duo, and the most seasoned directly manage slices of the portfolio. They harness their experience and expertise by employing a long-term approach, allowing them to tap into insights their many shorter- term-focused rivals miss. The fund’s girth may limit the extent to which its strengths can shine through, but it still has the makings of a long-term outperformer.
Fidelity Contrafund FCNTX
At $85 billion in assets, this large-growth fund has plenty of investment dollars to spread around. Even so, the fund holds concentrated positions in some big names, including Apple AAPL at nearly 9% of the portfolio and Google GOOG at 5%. In fact, the fund is the leading shareholder in each of these tech behemoths, along with several of its other top holdings. Despite its heavy commitment to these bellwether stocks, the fund is no index hugger. The fund’s active share, a measure of portfolio overlap, clocked in at 73% versus the S&P 500 Index over the past decade, meaning just 27% overlapped with the bogy. Longtime manager Will Danoff has accomplished this in part through investments in overseas stocks and midcaps that aren’t in the index. The fund has performed well in all types of conditions but shines during bear markets in particular. The fund’s 10-year annualized return of 9.5% is 2.5 points better than the category average.
Oppenheimer Equity Income OAEIX
Mike Levine uses an eclectic strategy designed to maintain a dividend yield higher than that of the Russell 1000 Value Index. He keeps 80% to 85% of the portfolio in stocks, mainly stable large caps with growing earnings and a free cash flow yield that’s higher than their dividend yield. Most of these stocks pay healthy dividends, but Levine will sometimes hold stocks with no dividend if he expects them to initiate one in the next couple of quarters. The remaining 15% to 20% of the portfolio goes mostly into convertible securities, including convertible preferreds. Levine likes convertibles because they often provide substantial income with relatively low volatility and also because they can provide access to companies that don’t pay a dividend. The fund’s asset base has ballooned from $259 million in October 2008 to nearly $3 billion as of mid-2012, thanks to its strong performance and the popularity of equity-income funds in a period of rock- bottom interest rates. Overall, Levine has turned it into a pretty good option among equity-income funds.
Royce Total Return Investment RYTRX
Managers of this small-blend fund look for firms with strong balance sheets, stable earnings, high returns on capital, and selling at a 30% to 50% discount of what they think the companies are worth. At least 90% of the companies in the portfolio must pay a dividend. The managers use a low- turnover approach with a three- to five-year time horizon. The fund’s conservative philosophy has helped it hold up well during down markets as compared with its small-cap peers but also can hold it back in rising markets. The fund’s returns have been in the average range for the category, but its low Morningstar Risk rating tells more of the story. Morningstar analyst Karin Anderson says the fund is “best-suited to patient investors who are looking for a smoother ride” in a small-cap fund.
T. Rowe Price Small-Cap Value PRSVX
A changing of the guard is coming for T. Rowe Price Small-Cap Value. Manager Preston Athey will step down from his role in June 2014. Athey, one of the longest-tenured small-cap managers around, has guided the fund to a strong record during his 21-year tenure: The fund’s 12% annualized gain beats the Russell 2000 Value Index by more than 1 percentage point annualized and beats nearly all small-value and small-blend offerings that have been around that long. Athey’s signature low-turnover, diversified approach has also kept volatility in check, with the fund losing significantly less than its peers in market downturns. David Wagner, who has served as the fund’s associate manager since 2005, will succeed Athey.
Vanguard Windsor II VWNFX
A veteran management team runs this large-value fund’s portfolio, with most managers running concentrated subportfolios of 60 or fewer stocks. Manager Jim Barrow, who runs most of the portfolio, looks for strong companies offering above-average yields at below-average valuations. Technology, which the fund once avoided, now makes up 11.2% of the portfolio, about 5 points more than its benchmark. Health care is another area that has an overweighting, while energy has an underweighting. The fund’s five-, 10-, and 15-year annualized returns all land in the top third of its category, while expenses, at 0.35%, are low for the large-cap no-load group, not to mention for an actively managed fund.