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Fund Changes Bring New Analyst Ratings

Tue, 23 Apr 2013

Morningstar's Russ Kinnel examines recent fund Analyst Rating upgrades and downgrades and offers guidelines for investors who own these funds.

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Video Transcript

Christine Benz: Hi, I am Christine Benz for Morningstar.com. Roughly 1,100 mutual funds currently earn Morningstar Analyst ratings, and our analyst team is constantly reviewing their ratings on the various funds they cover. Joining me to discuss two recent upgrades and two recent downgrades is Russ Kinnel. He is director of fund research for Morningstar. Russ, thank you so much for being here.

Russ Kinnel: Good to be here.

Benz: Russ, let's take it from the top and start with the bad news. A couple of notable funds that we liked more in the past, we've recently downgraded. Let's start with Artio International. They've got two funds Artio International Equity, as well as International Equity II. We used to like them a lot. Now we've got them down to Neutral.

Kinnel: That's right. The issue there is that Aberdeen is buying Artio, and they said that managers are not going to stay with the funds, most likely after the deal goes through. So, definitely big changes are coming. We don't know exactly what's going on, but it's enough to take us to Neutral because you now say the managers are probably leaving and we don't know who is replacing them.

Benz: So the managers are going to leave as part of the deals?

Kinnel: That's what they said is that they expect they will leave. They didn't say definitively, but it's enough for us to take them to Neutral.

Benz: Typically when you see a manager change is that necessarily cause for a downgrade or is it kind of a case-by-case [judgment]?

Kinnel: It's cause for review, but it's definitely case-by-case. You really want to understand who is left? How central are they to the process? So you really want to look at it on a case-by-case basis, but you really want to take a close look whenever that's happening.

Benz: So, if I'm an owner of this find, is this a cause to consider selling? How should I review this downgrade or see it in the context of what portfolio maneuvers I should make?

Kinnel: I think you might want to consider selling. You could hold and see who comes on. Or if you know there's another good fund out there, you might want to just switch because at a minimum it seems this fund is likely to get new managers and probably a new strategy. Now, it's possible they'll be decent. So, if you want to be patient you can or you can simply say, "Let's look for a new replacement and get one of the best funds out there."

Benz: Another fund with some manager issues recently, T. Rowe Price Health Sciences, a fund we liked a lot in the past and a fund that certainly had very good performance under manager Kris Jenner. There is some uncertainty there, and that in turn has prompted a downgrade.

Kinnel: Yeah. We don't often go all the way from Gold to Neutral, but we did in this case because Kris Jenner is taking two analysts with him and leaving the firm. He really had a great record at the fund, and now you've got one of the analysts promoted to take his spot. But that leaves some gaps in coverage at the fund. So, really it's a big change for the fund. We don't often go from Gold to Neutral, but it's seems warranted here.

Benz: So, again if I own this find should I sell it? What would you say my decision-making should be?

Kinnel: I would certainly consider that, look at other health-care funds. Also look at your tax situation. Jenner had a really nice return there. You might have a big taxable gain if you sell, too, so think about that as well. But it's definitely a big change and really a big drop in coverage and management quality there. So, I would take a long hard look at it.

Benz: I guess, a question is, if a fund has a change this significant and you think it's really a blow that Jenner is leaving, why not move it even further down? Why do we hold it at Neutral?

Kinnel: Well, because now we're in the unknown. We don't view it as Negative. Negative would mean we think it's probable that it will have a poor risk-adjusted performance in the future. We don't go that far, but we do think you're kind of back to Neutral--you have someone who doesn't have a track record, you have some gaps and coverage. Historically, the fund has done well, so that's a positive. But Neutral often means simply that there are a lot of unknowns, and that's the case here.

Benz: I would think T. Rowe Price's general record on stewardship, as well as relatively low costs, would be saving graces here, as well?

Kinnel: Yeah. T. Rowe across the board has strong performance at their funds, so that's really a positive. I'd tell you the analysts are probably pretty good still on the fund. But there are some gaps and even at T. Rowe the managers are still really important.

Benz: Now Russ, let's move over to the good news. Artisan Small Cap is a fund that we previously had rated Bronze; it has moved up to Silver. What prompted the change there?

Kinnel: Well, it's interesting what Artisan did when two longtime managers of fund retired in '08 and '09. Craig Cepukenas, who was a comanager there has stayed in place. What they did was they moved Craig Cepukenas to Andy Stephens' team who you know from Artisan Mid Cap. What we found over time is, it's seems like that team is really meshing. He is working well with that team. So it actually has worked out to be an upgrade. We took a while, it happened in '09. We have liked the way the team has worked. We've liked the way Cepukenas has picked stocks so far, and Stephens' team is a really strong cohesive team. And things seem really to be clicking there.

Benz: Another fund that has recently seen an upgrade is GoodHaven Fund. First let's do a little bit of stage-setting on this fund because it may not be a familiar name to some of our viewers. Let's talk about the fund's past history and the pedigree of these managers.

Kinnel: Sure. Larry Pitkowsky and Keith Trauner were formerly comanagers at Fairholme, and they set out about three years ago to launch GoodHaven. They left Fairholme, and they have the backing of Markel, a well-known insurance company and investor. They've really set about building the shop the right way. But we took our time; we wanted to get to know their process and the firm and see if what they said is how they actually executed. So we're at a point now where we feel pretty good about that, so we raised the fund to Bronze. They run a focused value-oriented strategy, a lot like you'd see at Fairholme, though they de-emphasize financials, which of course is [a sector that] got Fairholme in trouble.

Now, one of the tricky parts here is that we know that these managers contributed to Fairholme's success, but obviously [current Fairholme manager] Bruce Berkowitz is the lead dog therein and deserves most of the credit. So, we can't give them all the credit and simply say they are going to replicate what Fairholme did. But we can see that they are doing a good job so far and that they are executing this strategy the way we expect. It's still a bold-focused strategy. So that's not to suggest that it's going to be a lower-risk version of Fairholme, but it's a really intriguing fund.

Benz: So how do you evaluate a situation like this where you've got some managers who are not just trying to run their new fund, but they are also simultaneously setting up a firm? How do you try to assess whether the managers can successfully pull off that balance?

Kinnel: You really have to get to know everyone else at the firm, the analysts, other people handling the management side. You have look at their own management skills; you have look at who they brought in to help them out. So it's a little more involved than say your typical firm. We mentioned T. Rowe, and obviously there, you don't have to reinvent the wheel and investigate the firm all over again for one individual fund. We know that they've got a lot of good things in place. But it's a little more involved in a case like [GoodHaven], especially with a new operation. But we felt really good as over time, we had a lot of discussions with them.

Benz: Russ, one thing that often concerns investors as they look at brand-new funds is that their expenses can be a little high. How does GoodHaven measure up from that standpoint?

Kinnel: It's OK. It's 1.1%, which is a little pricey for a large-cap fund, but for a fairly new fund, it's not bad. So, we rate the price pillar as Neutral, and so price is OK. Hopefully assets will grow, and that [percentage] will come down a little. But it's not great. If you know Fairholme, that's long been around 1%. So, it's kind of, I think priced in a similar fashion.

Benz: One other issue is Fairholme arguably got a little bit large, the asset inflows were coming in a very strong fashion for a period of time. Have these managers of GoodHaven signaled that they will close at a certain level?

Kinnel: Yeah, they've said that they are much more aware of asset size and I think are going to be more inclined to close early. Obviously, they haven't given an exact number, and we will have to see how that goes. But yeah, they certainly indicated a greater sensitivity to that.

Benz: Russ, thank you so much for being here, and sharing this wrap-up of recent upgrades and downgrades.

Kinnel: You are welcome.

Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.

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