Jeremy Glaser: For Morningstar, I am Jeremy Glaser. We launched our Morningstar Analyst Rating for funds for the closed-end fund universe about nine months ago. I am here today with Cara Esser. She is a closed-end fund analyst. We are going to look at the ratings and how they've shaken out so far and what she expects to be some of the best-performing funds in the future.
Cara, thanks for joining me.
Cara Esser: Thanks for having me.
Glaser: So, let's talk a little bit about how you chose the funds to rate and the metrics you use to evaluate these funds.
Esser: We chose the closed-end funds based on size essentially. We wanted to get a good sampling across all of the different strategies that are offered in the closed-end fund space, and as many investors in closed-end funds know, a lot of them are very small. So, we wanted to make sure that we were covering the largest funds that had the most interest, the largest trading volume. Essentially, we picked the largest funds, and then if there were any sister funds that fell below our minimum level of asset requirement, we covered those, as well.
Glaser: What exactly are you looking at? When you evaluate a fund, you decide, "Hey, this is something that we're going to give high rating to, something that we are going to give a negative rating to." What are you looking at?
Esser: Unlike the [Morningstar Rating for funds, commonly referred to as the star rating] which is totally backward-looking based on historical risk-adjusted performance, the Morningstar Analyst rating for funds is purely forward-looking; it's a qualitative rating. We have five pillars that we look at. We call them the four Ps plus fees. So, it's performance, process, people, and parent.
Historical risk-adjusted performance does play a part in the role, but it's only one of five of the pillars. So, we look at the process. We want to know if it's a process that we can understand, that we believe, and that the managers know how to implement successfully and have been able to do so in the past.
We look at the management team, the people. Have they been with the fund for a full market cycle? Is it a cohesive team? Is there a lot of turnover? Do they own shares of the fund?
The parent, we're looking for parents that are good stewards of capital. We want to make sure that they are invested in the long-term shareholder, that they are making decisions that are good for the long-term shareholders and not making decisions based on any kind of short-term trading.
And then fees, obviously, we want to find funds that have low fees. We always prefer low fees over high fees.
Glaser: How have the distributions of the ratings have shaken out so far?
Esser: We have five ratings. Three of them are positive: gold, silver, and bronze. And we have a neutral rating and a negative rating. You would expect that most of the ratings would fall in the neutral to bronze range. So, gold is our highest conviction. All gold, silver, and bronze are positively rated funds. So, we do expect those funds to outperform on a risk-adjusted basis going forward against peers in a benchmark. But the gold-rated funds we would say are our highest conviction. We really think that those funds are the best of the best.
As expected we have a lot of neutral and a lot of bronze-rated funds. The distribution as of the end of the summer, Aug. 31, we have 115 closed-end funds currently rated. We have five gold funds, 21 silver, 44 bronze, 41 neutral, and 4 negative.
Glaser: If you look at those gold funds, what are some of your favorite funds? What should investors really be looking at in the closed-end fund space?
Esser: Our gold funds are across all of the strategy spectrums that we have. Again, we are looking for the best of the best. So, you'll never find an entire strategy that's rated highly because we want you to find the best of those funds.
We have five of those funds, like I said, so we have a domestic fixed-income fund, Alliance Bernstein Income, ticker ACG, and they mostly invest in government and corporate bonds; Royce Value Trust, RVT is the ticker, and is a small-cap domestic equity fund. We have a large-cap domestic equity fund, Gabelli Equity, ticker GAB; an emerging-markets fixed-income fund, Aberdeen Asia-Pacific Income, ticker FAX, and finally we have a global real estate fund that has a gold rating. It is CBRE, Clarion Global Real Estate, ticker IGR.
And all these funds have been around for quite some time. Four of the five have inception dates of 1987 or earlier. So, these are funds that have been around for a long time. They have been through the market cycles. We like the management teams. We like the processes. They've performed well up to this point and we expect the performance to continue in the future.
Glaser: Cara, thanks for talking with me today.
Esser: Thanks for having me.
Glaser: For Morningstar, I'm Jeremy Glaser.