Thu, 29 Aug 2013
Director of fund research Russ Kinnel explains how Morningstar analysts rate some of the fund world's biggest recent asset gatherers (and losers).
Christine Benz: Hi I'm Christine Benz for Morningstar.com.
What do Morningstar's fund analysts think of the fund world's biggest asset gatherers and losers?
Joining me to discuss that question is Russ Kinnel, director of fund research for Morningstar.
Russ, thank you so much for joining me.
Russell Kinnel: Good to be here.
Benz: Russ, let's talk about the fund world's biggest asset gatherers year-to-date. You took a look at some of the funds that have been garnering the biggest investor inflows. At the top of the list is PIMCO Unconstrained Bond. I know that initially, we are lukewarm or not sure what to make of this non-traditional bond category. The fund has been around for a little while now. What kind of rating does that particular fund garner currently?
Kinnel: We give it a Bronze. It's a really interesting strategy. They have more leeway to go up and down in duration--they can even go negative duration, which means they're betting that rates will rise. So it's got more flexibility. With interest rates rising lately, that has a lot of appeal. But it still hasn't really proven itself through a full cycle, so Bronze, not Gold. We want to see it prove a little more, but we do think there are some good people in place there.
Benz: Within that non-traditional bond category, are there any funds that we rate as really high-conviction at this point in time?
Kinnel: Yes. FPA New Income, we give a Silver to.
Benz: That's been around a long time.
Kinnel: Right. Very proven. It's not as wild as some of the non-traditional bond funds, because they're not going to short duration. It's just a very cautious fund, run with the idea of preserving capital, not losing much, and when available, they'll go for yield and income, but generally it's all about defense.
Benz: Mentioning those two funds together, it really showcases that that category is a broad basket; you've got a lot of different strategies. You probably want to know what you own before you buy it.
Another fund that you noted has really been doing quite well in terms of gathering new investor dollars is a fund that we've known for a long time: Oakmark International. Where do we have that fund in terms of its current rating?
Kinnel: We rate it Gold, and at the moment, you can understand why it's getting a ton of inflows, because it's in the top percentile in almost every trailing period--just amazing performance. It's got a good, strong deep-value strategy. David Herro is a very proven manager with a great track record. He is sometimes wary of emerging markets. Currently, the portfolio does not have much at all there, and that explains part of the strong recent performances. Emerging markets have lagged developed markets, and so that makes the fund look particularly good.
That said, there is definitely a caveat, because it is a rather focused value strategy. If you look at the year-on-year returns, there are some years where it'll have a rough go of it. So, don't expect a smooth ride, and recognize that it if you're buying today, obviously you're buying after a good run, which is not probably the best time to go in.
Kinnel: That was my question for you, Russ. Anytime you see top percentile ranking across the board, does it make you want to run the other way, or maybe you downplay your holdings?
Kinnel: When I see a fund that's top percentile across the board, and it's getting a ton of inflows, I worry. Now, I have a lot of confidence in Herro. I like the fact that he and others at Oakmark generally are willing to close funds when needed. So, that makes me worry a little less about inflows. But still, you have to recognize that maybe this is close to the top for that strategy. We know some of the other people who used to be at Harris, some of their similar funds, like Artisan International Value, are also doing really well. So, it does seem to be particularly near the top for that strategy. It doesn't mean it's going to roll over and be awful tomorrow, but I would definitely be a little cautious.
Benz: Let's take a look at the other side of the ledger, the funds that have been seeing redemptions recently. At the top of the list is PIMCO Total Return. Let's talk about where we have it rated currently and your near-term view on the fund as well as your long-term perspective?
Kinnel: PIMCO Total Return, we rate Gold. We still think it's an outstanding fund, not just because of Bill Gross, but because of the tremendous resources and analysts and traders that they have. But they held a lot of long TIPS, which was about the worst place to be in the high-quality bond world this year because we had inflation decline, which hurt TIPS, but interest rates went up--a worst-case scenario for TIPS--and that hurt the fund. It's down about 2.5%-3% for the year-to-date. So, I think people are disappointed, but it's still a good fund with very good long-term prospects.
It's funny, if you put that one against PIMCO Unconstrained, which is getting a lot of inflows, PIMCO Unconstrained is down 1.7%, so it's only doing 100 basis points better than Total Return. If you think about it, if you're buying PIMCO Unconstrained, you're saying, I want to give PIMCO more leeway, but at the same time, other people are selling saying, we've given them too much leeway. I don't know; it's a funny juxtaposition. But I think they are still both good funds. I think Total Return is a good core fund, but it is showing its aggressive side, that they make bets versus their benchmark. Most of the time they are right, but a couple of times in the last three years, they have been wrong.
Benz: It can get caught leaning the wrong way at various points in time.
Benz: Let's talk about a couple of the other bond funds that have been seeing outflows recently, a couple of Vanguard funds. The Inflation Protected Bond Fund, you outlined that TIPS inflation-protected securities have had a difficult run of it recently. Also Vanguard Ginnie Mae is on the list of funds that investors have been selling.
Where do we have those in terms of their current ratings, and what are the near-term prospects for the funds as well as the long-term outlook?
Kinnel: We rate both funds Gold because they don't take a lot of risks or give you a lot of surprises, and they have very low cost, which is what you want for a Ginnie Mae or a TIPS fund. There is not a lot of value to add, and the yield isn't very big, so you want fees to be very low. They do that, and they do a good job of managing the portfolios. But clearly, some shareholders in these funds were surprised by that interest-rate risk. And interest-rate risk is what you often get with a very high-quality fund. So, there is not much default risk. There's the government backing behind both of these, but you do have some interest rate risk, and I think people were surprised by that--at least some people.
Benz: We had that interest rate shock from early May through early July, and people just seemed to get very worried about the interest-rate sensitivity in their bond holdings, as perhaps they should have done.
Kinnel: They should. Though certainly, it's one that was well telegraphed. For years, we and everyone else have been talking about how interest rates could spike and how some of these funds with very low yields and fairly long duration are at some risk.
Benz: The last fund we wanted to cover today is Permanent Portfolio. I know it's a fund that a lot of our Morningstar.com users were very excited about a couple of years ago. It's seen performance drop significantly, and investors appear to be selling. What's the rating for that fund and what you think has been spooking investors recently?
Kinnel: We rate it Neutral, and what's spooking them is the fund has a big gold bullion stake that's just been murdering it as gold has gotten really crushed. And we rate it Neutral, because we think if you back out the asset exposure there, you could get it much cheaper via ETFs, but the managers are not really adding any value, and they're not making any allocation calls. As the name implies, that allocation is fixed.
Benz: What else is in the portfolio?
Kinnel: There's actually an active equity strategy in there, and a few other pieces, none of which are very appealing. And so, it's really not that attractive. I think people were maybe … reading too much into its strong performance. Having lot in gold bullion was a great recipe for its success relative to other allocation funds up until about a year and half ago.
Benz: In the bear market, it held up quite well.
Kinnel: In the bear market, it looked brilliant, but now it doesn't. I think it's just a case of confusing a fund's asset mix with skill, and if you look at it on a percent-of-assets basis, this fund is probably getting heavier redemptions than just about any other fund. So, I think unfortunately it means that maybe some people didn't understand what they were buying.
Benz: So, even if you want this type of exposure in the portfolio, you think that you can build your own portfolio and do it much more cheaply?
Kinnel: You can do it much more cheaply. Where this fund is active, they haven't added value, so you're really not getting much for fairly high fees. So, we're not big fans.
Benz: Russ, thank you so much for being here to discuss some of our calls on these funds. It's really helpful information; we appreciate it.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.