3 Great Funds Having a Lousy Year

Susan Dziubinski: Hi, I'm Susan Dziubinski with Morningstar. Morningstar assigns high fund Analyst Ratings to strategies we think will outperform a relevant index or their peers over a full market cycle. But that doesn't mean that there won't be some bumps along the way. Joining me today to talk about three Gold-rated funds that are having a struggle this year is Russ Kinnel. Russ is Morningstar's director of Manager Research and editor of Morningstar FundInvestor.

Hi, Russ, thank you for joining us today.

Russ Kinnel: Glad to be here.

Dziubinski: First, let's talk a little bit about underperformance in general, Russ. In what instances might underperformance simply be a temporary phenomenon--maybe a manager style is out of favor, or maybe there's been a misstep. And then how can you tell when really something more dramatic is going on that might lead to a downgrade?

Kinnel: Yeah, if you own a fund for a period of 10 years, even the best fund is going to underperform for a couple of those years. So you have to understand going in that you've got to tolerate some of that from the get-go. And as you say, often it's simply a matter of a fund's style being out of favor. When a fund's going really good, it might seem like the manager is ahead of the curve and has their finger on the pulse of the market and is always going to be ahead of the curve. But that doesn't really sync with reality. So funds tend to have favorite sectors; they tend to have a style bias toward value or growth. And all those things factor in, so you kind of expect in different markets that different funds will underperform. Where we get concerned is if it's prolonged, if they reveal mistakes we don't think they should have made. So that's when we start to worry. But simply underperforming for a year is not necessarily a big deal.

Dziubinski: Just to be clear, the three funds that we're going to talk about today, they're all struggling a little bit this year, but we've retained our Gold ratings on all of them. Right?

Kinnel: That's right. So the Gold rating tells you that we definitely believe in these funds, even though they're struggling. So a bad year, but it's still Gold because our analysts essentially are reaffirming a rating every day there at work. So if it's still Gold, that means we still have faith.

Dziubinski: The first fund that we're going to talk about that's having a little bit of a hard time this year is Brown Capital Management Small Company BCSIX. This fund's actually in the red for the year to date through the middle of August. What's going on there?

Kinnel: Yeah, this is a good fund, very fundamental-earnings-growth-driven, but it's very aggressive. Huge weights in tech and healthcare, and so you kind of expect every few years, it's going to have a tough year like this. In this year small growth, particularly small tech and healthcare, have done worse than large growth in tech. So you can really see the fund is suffering for it. But it had a really nice run the prior year and its long-term record is still really robust.

Dziubinski: The next up is FMI Large Cap FMIHX, and the returns for that fund are landing near the bottom of the large-blend category this year. What's going on there?

Kinnel: Yeah, this one's maybe the one disappointment of the three we're talking about because it is a valuation-sensitive fund and value has done better than growth for the most part this year. So you would kind of expect it to do well. What's holding it back right now is it's got a lot of consumer defensive stocks, particularly European names like Unilever UL, that have really been sluggish. And while the economy is really coming back, and economically sensitive stocks are charging ahead, these more-defensive ones are holding back, and that's kept the fund in the bottom decile for the year.

Dziubinski: Pivoting over to the bond side, Western Asset Core Plus Bond WACPX is landing in the bottom decile of its category, which is pretty notable considering this fund has been a top-half performer for nine of the past 10 years. What's going on there?

Kinnel: Yeah, this is a good fund, but fairly aggressive as that "plus" indicates in the bond world. And they tend to be long duration. They've been sceptics about the story for a long time about "inflation is going to come back and it's going to ruin the bond rally." And as you note, most of those 10 years they've been right. But this year, the economy has been strong. Worries about inflation have come back. So the long end of the yield curve has gotten punished a bit. And given their longer duration they've also suffered for it.

Dziubinski: Well, Russ, thank you so much for putting the performance of some of these funds in perspective. Sounds like investors should keep the faith this year with them, right?

Kinnel: I certainly would. Yes.

Dziubinski: Thank you for tuning in. I'm Susan Dziubinski with Morningstar.