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By Christine Benz and Shannon Zimmerman | 05-30-2013 12:00 PM

When Our Analyst Ratings Diverge From Fund Performance

Below-average returns don't shake Morningstar analysts' confidence in some funds, while recent outperformance doesn't grant higher ratings to others.

Christine Benz: Hi. I’m Christine Benz for In certain cases Morningstar’s forward-looking Analyst Ratings might seem to run counter to funds' near-term performance. Joining me to discuss some examples of that is Shannon Zimmerman. He is associate director of fund analysis with Morningstar.

Shannon, thank you so much for being here.

Shannon Zimmerman: Good to be with you, Christine.

Benz: Shannon, first, let’s talk about how the analysts come about their forward-looking ratings. What sorts of factors are they taking into account?

Zimmerman: We have five analytical pillars, so among the things that we look at are the people who run the fund and the analyst team that support the managers of the fund; price; performance; process; and the parent company behind the fund, too, because if there is not a strong investment culture at the parent company, that can trickle down to the day-to-day running of the mutual fund, as well. So those are the five areas that we look into. Then, as you say, our assessment doesn’t always match up certainly with recent performance.

Benz: So performance is one of those pillars, but just one. So let’s take a look at a few examples of funds that have had maybe not great recent performance but that we still give very high ratings to. Let’s start with Dodge & Cox Stock. It’s a name that’s well-known to a lot of our viewers. Let’s talk about what’s been going on with that particular fund over the past three and five-year periods, and also why we still have conviction in that fund’s ability to outperform.

Zimmerman: Well, the reason we have conviction is, it has a fine long-term track record. The management team is very experienced, and the longest senior manager on the fund started in 1977, John Gunn. It has low costs, and we found in our research, an expense ratio can be quite predictive of outperformance if it's below-average in cost, and of underperformance if it’s above-average. They prize intensive, pain-staking research. They are very much focused on fundamentals and are not trying to make sector calls in terms of what’s going up and what’s going down. They just focus on individual businesses to invest in for the long haul, and it’s a Gold-rated fund for us from the Analyst Rating perspective.

But over the last five years, it’s below-average in its category. I think it’s in 53rd percentile over the last five years in the large-value category, and just outside the top third over the three-year period. So if we were only looking exclusively at performance, well, then we wouldn’t have an Analyst Rating; we would just rely on the Morningstar Rating for funds. But in this case, the analyst who covers it, Dan Culloton, my colleague, thinks that the forward-looking prospects for the fund are quite strong, and it’s hard to argue with him. It’s a Gold-rated fund despite the sort of subpar recent performance.

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