Work the Morningstar Fund Screener to Your Advantage

We've got style!

No, we're not talking about the clothes we wear, the music we listen to, or the cars we drive. We're referring to the way we all invest. Large value. Small growth. Contrarian. Momentum. We've come up with an entire lexicon aimed at describing the many stripes that we as investors--or the managers whom we hire to run our money--wear.

But why do these distinctions exist in the first place? There's the human dimension--it satisfies an impulse to classify and refine, helping us to place an unwieldy universe into a more comprehensible framework. But there are also more-prosaic forces at work: We like to measure, compare, and contrast. How has one income-oriented value manager fared versus other managers of that ilk? Does a momentum-growth style provide greater diversification potential than a growth-at-a-reasonable-price approach? How have mega-cap-focused managers done versus their all-cap brethren? These aren't trivial concerns, as slightly distinct flavors of investing can confer very different risk/reward profiles.

Of course, narrowing down the field to particular brands of investing is no simple feat. True, you can search for all large-value funds using the Morningstar Premium Fund Screener. But what about, for instance, homing in on contrarian bargain hunters? That's much more difficult to do, as there's no one data point that can be used to identify a manager as such.

But searching for particular substyles isn't a hopeless cause. In fact, with a little intuition and elbow grease, you can create a screen that, if imperfect, gets you much closer to distinguishing styles at a more nuanced level. To illustrate how, let's return to the earlier example of contrarian value managers. Contrarian investors gravitate to stocks that have broken down fundamentally or operate in industries that have fallen out of vogue. They do so largely on the premise that the market often goes too far in punishing such stocks or fails to duly appreciate the fundamental strengths that they possess. The recovery thesis can take various forms, with catalysts such as management changes, strategy shifts, restructurings, cyclical recoveries, and consolidation among those most commonly cited by contrarians.

These telltales are important to keep in mind when crafting your search. A contrarian is most likely to play in a part of the market that has been under pressure recently or seems to be in the early stages of recovery. What areas fit the bill? The telecom services arena--which in recent years has been plagued by a huge supply glut, badly stretched balance sheets, and withering competition--comes to mind. Regional and long-distance carriers took a drubbing during the bear market as those problems were exposed. But more recently, that industry has been host to a flurry of deal-making, as SBC Communications  (SBC) announced it would buy long-distance carrier AT&T (T), and Verizon Communications  (VZ) bid to acquire AT&T's chief rival MCI . These pairings are part of a flight toward consolidation, as carriers strain to achieve the greater scale needed to wring out cost savings and stanch the bleeding caused by intense competition.

Because those dynamics are likely to catch the eye of a committed contrarian investor, you can incorporate funds' telecom sector weightings into your screen. Specifically, screen for funds that are holding above-average telecom stakes.

Here's how the full screen would work: First, we'll locate large-value category members, and we'll specify distinct portfolios only so that we don't have to look at multiple share classes. Then, we'll ask that the fund's telecom weighting be 5.99% or higher. (Note: When you start looking at sector weightings, the fund screener will show you quartile cutoffs for a category, and 5.99% is the low end of the large-value category's top quartile.) Also, because you might want to buy one of these funds, we'll add three more lines. We'll demand low expenses of 1.25% or below and a manager tenure of at least three years. We'll also weed out any funds that are closed to new investors.

As of Feb. 24, this screen yields 24 funds. Click  here to run it yourself.

So, now that we've put our intuition and Premium Fund Screener to work, we're done, right? Not quite. For the telecom sector is home to a wide variety of firms, not all of which would whet the tastes of a contrarian investor. In other words, a big telecom bet does not a contrarian make. Moreover, when and why a manager bought a stock says a lot about whether the purchase was opportunistic or not. That is, while our screen tells us which managers recently owned big telecom stakes, it doesn't indicate the rationale or timing of the purchase. For instance, the four American funds flagged by the screen aren't really looking for out-of-favor industries or firms so much as strong dividend yields.

The moral to the story? Once you've done a screen to identify funds that fall within a particular substyle, you have to roll up your sleeves and dig a little deeper. In the case of our screen, that means clicking over to each fund's analyst report (if available) and taking a closer look at the way we've described the manager's strategy. This will offer the best clues yet into whether you're looking at a true contrarian stock-picker or a manager who perhaps has gravitated to the telecom sector for another reason, such as dividend yield. That's exactly what I did in coming up with the shortlist of funds below, all of which were among the 24 funds in our original screen and are run by committed contrarian stock-pickers. We're fans of the first two offerings and think that the third looks promising.

Manager Bob Baker believes that investing in firms that are out of favor is a great way to make money. This includes diving into cyclical firms during troughs as well as buying firms mired in controversy. In April 2003 this fund devoted 5.4% of assets to Sprint  and Verizon, and by late 2003 more purchases in those two stocks and the addition of SBC Communications led to a 2003 year-end weighting of 10.5%. While those three stocks didn't do very well in 2004, they didn't slide much more either, and they're all three involved in mergers at this point. Note that Baker is now fishing through big pharma, another recently roughed-up area.

 Fidelity Equity-Income II (FEQTX)

While Stephen Dufour keeps a keen eye out for dividend-paying firms, he has also firmly established his fondness for firms that have had problems but could potentially recover. Mind you, it doesn't always work out well, as a recent rough patch for the fund has shown. It's often patience that counts in pulling off a contrarian strategy, and he's got that. The fund headed into 2004 with 4% of assets in Verizon and a small SBC stake. He bought more of both of those stocks through the years and added Sprint along the way as part of a 9% telecom stake that leaned heavily toward regional bells at the end of 2004.

 AXP Diversified Equity Income (INDZX)

Warren Spitz has been lead manager here since late 2000, during which time he's turned this longtime laggard around. He's a bit more of a sector rotator than Dufour and Baker, having made big forays into energy and materials firms of late, as well as telecom. He built up the fund's telecom stake in 2003, starting with BellSouth , AT&T, and SBC and adding Sprint and Verizon along the way. The fund had an 8% stake in those firms at the end of the year 2003 and much remains the same today. He also added MCI in December 2004.