Inside Morningstar's 401(k)
The 23 funds that made the cut to get into our 401(k).
Let's take a look at the funds in Morningstar's 401(k). I'm one of the people on the committee that selects the lineup, and I can tell you that we try hard to keep it in peak form. The funds are chosen for strong fundamentals such as cost, management, stewardship, and strategy. We want funds that work together, so it isn't simply a matter of choosing our 20 favorite funds in the world. In addition, we do build in some overlap, so we don't intend for employees to own one of everything.
We want great funds for the long haul, and, as you'll see, we don't play favorites with one fund company or sales channel. We do have a fair amount of institutional share classes of funds because those are the cheapest, but the investor share classes of these funds are also good choices.
Let's begin with our latest change, and then I'll walk you through the rest of our U.S.-stock funds, our international-stock funds, and our bond funds.
We replaced Allianz NFJ Small Cap Value (PSVIX) with Royce Special Equity (RSEIX). We like the Allianz fund, but NFJ wanted to reduce its asset base for this fund, so it decided to stop taking new money from midsize 401(k) providers, including Morningstar's. That meant it had to go, as it isn't practical to have a fund in the 401(k) if it won't take new investments.
We chose Royce Special Equity over other worthy small-value and small-blend funds because it is a well-run value strategy with a seasoned manager. Charlie Dreifus focuses on companies with clean accounting, healthy balance sheets, and shares trading at modest valuations. It's a strategy that has historically held up well in bear markets. We like the added level of diversification it provides. Royce Special Equity lost less in 2008's market crash than any of the other candidates we looked at, and it doesn't track our other funds as closely as other candidates do.
We also like the fact that, in the past, Royce has closed the fund to new investors when assets were at a modest level.Morningstar Category Expense Ratio Manager 5-Yr Total Ret Total Ret % Rank 5-Yr Amer Funds NewWorld (NEWFX) Div Em Mkts 1.04 Multiple 6.18 50 Amer Funds WashMut (RWMFX) Large Value 0.36 Multiple 0.53 17 Dodge & Cox Intl Stock (DODFX) ForeignLgVal 0.65 Multiple -0.62 16 Harbor Capital App (HACAX) Large Growth 0.67 Spiros Segalas 4.09 17 Loomis Sayles Bond (LSBDX) Multisector Bd 0.64 D.Fuss;K.Gaffney 7.69 14 MorgStan InstUSRealEs (MSUSX) Real Estate 0.99 Theodore Bigman -0.19 41 Oakmark Select (OAKLX) Large Blend 1.08 Nygren;Berghoef 0.66 28 Oppenheimer Dev Mrkts (ODVYX) Div Em Mkts 1.04 Justin Leverenz 11.50 1 PIMCO CommRealRetStr (PCRIX) CommBrdBskt 0.74 Mihir Worah 5.19 1 PIMCO Real Return (PRRIX) Infl-Prot Bd 0.45 Mihir Worah 8.05 1 PIMCO Total Return (PTTRX) Int-Term Bd 0.46 William Gross 8.39 4 PRIMECAP Ody AggGr (POAGX) Mid-Cap Gr 0.72 Schow/Fried/ 5.13 28 Kolokotrones/ Moredecai Royce Special Eq (RSEIX) Small Blend 1.04 Charles Dreifus 5.28 8 Selected American (SLADX) Large Blend 0.61 C.Davis;K.Feinberg -0.60 63 T. Rowe Price High-Yld (PRHYX) High-Yield Bd 0.76 Mark Vaselkiv 6.98 22 T. Rowe Price ST Bd (PRWBX) Sh-Term Bd 0.55 Edward Wiese 4.36 29 T. Rowe Price SC St (OTCFX) Small Blend 0.92 Gregory McCrickard 3.83 14 Vanguard FTSE Soc Ind (VFTSX) Large Growth 0.29 Michael Perre -2.10 97 Vanguard Instl Ind (VINIX) Large Blend 0.04 Donald Butler 0.34 34 Vanguard Intl Exp (VINEX) For Sm/MidGr 0.39 M.Dobbs;S.Thomas 0.16 68 Vanguard Intl Gr (VWILX) Foreign LrgBl 0.35 Multiple 1.41 6 Vanguard Selected Val (VASVX) Mid-Cap Val 0.47 J.Barrow et al. 1.96 29 Wasatch Sm Cap Gr (WAAEX) Small Growth 1.28 Jeff Cardon 4.90 17 Data through Sept. 8, 2011.
American Funds Washington Mutual (RWMFX)
This fund lagged from 2003 through 2005, but it's come out of it just fine. A focus on dividend-paying stocks trading at modest prices has kept this fund on the right path, as its long-term record shows. With $51 billion under management, the fund is enormous, but it's actually smaller than it has been in a decade, as that dull stretch spurred redemptions.
Some investors have concluded that a disappointing 2008 performance at some American Funds was caused by the firm's asset bloat; I don't think that's the case. Asset bloat was a problem at American, but it was a minor handicap rather than a major problem given its multimanager format and low turnover.
The real difference between the 2000–02 (when the firm outperformed) and 2008 bear markets was that the latter hit American right where it lives--in dividend-paying value stocks from financials and economically sensitive stocks, whereas the earlier bear market hit high-priced growth stocks while largely sparing large-value stocks.
Harbor Capital Appreciation (HACAX)
Manager Sig Segalas hasn't named a retirement date, but it's certainly a possibility considering he started his career in 1960. We've focused on the team behind Segalas at Jennison Associates and are pleased that he's built a strong team of growth investors around him. Thus, our recommendation of this fund is done with confidence that Jennison should continue to do well if Segalas were to retire. The strategy at Jennison is to blend high-quality with aggressive-growth names, and it's led to good long-term results.
Oakmark Select (OAKLX)
We stuck with this fund in our Analyst Picks list and in our 401(k) even though it had a slump in the mid-2000s, and we've been nicely rewarded. One reason we stuck with it is that even at its worst, its long-term record remained outstanding. We thought, why should near-term results outweigh long-term results when they didn't in the tally that counted most?
To be sure, manager Bill Nygren's bet on Washington Mutual was a big gaffe, but his body of work is clearly outstanding. This fund is a classic example of focused investing. There are hot and cold streaks, and you have to stick with the fund to get the benefit of its performance over a complete market cycle.
Primecap Odyssey Aggressive Growth (POAGX)
This fund's smaller-cap focus and more-aggressive positioning make it the most distinctive of the six Primecap-managed funds. The rest are much larger in market cap, though they vary slightly in how growth-driven they are. This fund has a mix of small-, mid-, and large-cap names that give it an average market cap of $3.5 billion. With a modest $1.2 billion in assets, this fund should be able to stay in our mid-growth category for a while.
The fund has top-third three- and five-year returns. We recommended it right out of the box because we've seen how Vanguard Capital Opportunity (VHCOX) fared when it started out with a small asset base.
Selected American Shares (SLADX)
You can see the case for this fund if you go to the Fund Spy Selector tool (mfi.morningstar.com) and plug in ticker SLASX. There, you'll see that since Chris Davis became a comanager, the fund has returned a cumulative 360% compared with 261% for the S&P 500. So, yes, recent performance isn't all that impressive, but as with Oakmark Select, we go with the long-term record, and this fund's is good. Davis/Selected had a financials-related slump in the early 1990s and rebounded, and I see no reason why that can't happen at Selected American.
T. Rowe Price Small-Cap Stock (OTCFX)
Greg McCrickard has made this a quietly effective fund. He's nearing his 20th year here, and you have to look back at the entire record to appreciate the fund. It just steadily kept ahead of its peers and the Russell 2000 through all kinds of markets. That consistent modest outperformance adds up to something at the end. From his start date in 1992, a $10,000 investment in the fund would have grown to more than $85,000 today compared with $68,000 for small blend and $56,000 for the Russell 2000.
The fund reopened to new investors in 2009 when the bear market was spurring redemptions, but I'd imagine the fund would close should fund flows pop up from their current low level.
Vanguard FTSE Social Index (VFTNX)
This socially screened index fund has a lot going for it. But past performance isn't one of them. It has superlow costs of 0.16% and a sound strategy. Yet, its pollution and other social screens have made it commodity-light and technology-heavy over the past 10 years, and that was not a formula for strong returns. (It also screens out companies involved in tobacco, alcohol, adult entertainment, firearms, gambling, nuclear power, and unfair labor practices.) Should that trend reverse itself, it should perform well.
Vanguard Selected Value (VASVX)
Jim Barrow is an expert at picking cheap stocks with potential, and you can hire him for cheap at this fund. This mid-value gem has been a standout since Barrow took the helm in 1999. He buys companies with big problems and bets that they'll recover enough to produce a strong return. Besides Barrow, 25%
of the fund is in the hands of Donald Smith, who also applies a deep-value strategy. The results have been quite consistent. The fund has hit the mid-value category's second quartile in seven of the past 10 years.
Wasatch Small Cap Growth (WAAEX)
Jeff Cardon has Barrow and McCrickard beat on tenure with 25 years at the helm. Cardon's emphasis on strong companies with healthy earnings has helped him guide the fund through a lot of wild markets.
He pairs steady growth companies with faster-growing ones in a way that works well over time. It's not always pretty, as the fund's 42% loss in 2008 shows, but its returns over the trailing three-, five-, 10-, and 15-year periods are all top-quintile.
American Funds New World (NEWFX)
It's an unusual portfolio mix, but this fund's most important attributes are its outstanding analysts, proven portfolio managers, and low costs. Generally, you pay much more for much less.
The unusual bit is that the fund takes a wide-ranging approach to emerging markets. About 60% of its stock portfolio is in emerging markets, but the rest is in developed-markets stocks that do a lot of business in emerging markets. In addition, it has about 10% of assets in emerging-markets bonds. It's really a pretty logical approach, as many developed-markets companies do a lot of business in emerging markets and you have greater legal protections in developed markets. However, no other fund has a similar mix, so this fund straddles the lines between three categories: emerging-markets stock, world allocation, and foreign stocks. Its performance is lower risk and lower return than the pure emerging-markets stock funds, but it is higher risk and higher return than foreign-stock and world-stock funds.
Dodge & Cox International (DODFX)
Ten years ago, Dodge & Cox launched a foreign fund because it was investing more and more overseas and felt it was time to launch a fund. Today, it has a 10-year return of 8.4% annualized, which is good enough for the top 3% in foreign large-value. The strategy is similar to that of the U.S.-stock fund: Buy cheap stocks that have been knocked down but boast strong management and dominant market positions. The fund now has a $40 billion asset base, so it may not quite match the past 10 years, but it's still a gem.
Oppenheimer Developing Markets (ODMAX)
This fund may be the most aggressive and volatile option in our lineup. Justin Leverenz seeks strong growth stocks from across emerging markets, and he's done well since taking the helm in 2007. The fund has returned a cumulative 38% versus 12% for the benchmark since Leverenz took over.
Vanguard International Growth (VWILX)
With three subadvisors running the portfolio, this diversified fund rarely produces big single-year returns. No one gets too excited or angry about this fund, and that's one of the reasons it's a good 401(k) fund. It just keeps plugging along, so investors can keep buying it with every paycheck. Solid management and low costs have kept it out of the bottom quartile in every calendar year going back to 2000.
Vanguard International Explorer (VINEX)
Vanguard added a second subadvisor, Wellington, to this fund in June 2010. However, that team appears mainly to be there to manage additional flows. So far, Simon Thomas and his team at Wellington are running only 1% of the portfolio. So, the fund is still very much a Schroder production with Matthew Dobbs at the helm since 2000. Dobbs looks for growth at a reasonable price with a focus on stocks that have market caps between $2.5 billion and $3 billion. The fund is a remarkably cheap way to gain access to small- and mid-cap foreign stocks. It has closed in the past but with Wellington on board, I'd guess it won't likely close in the near future.
Loomis Sayles Bond (LSBDX)
Multisector and world-bond funds like this one provide an added level of diversification to your bond portfolio. Just be sure you understand the risks. Kathleen Gaffney and Dan Fuss have produced a brilliant 10% annualized 10-year return, but it lost 22% of its value in 2008. Fuss and Gaffney move among high-yield bonds and foreign bonds in emerging and developed markets, including those denominated in foreign currencies. They look for where the best values are located, and historically they have delivered a lot of return for that added risk.
PIMCO Real Return (PRRIX)
PIMCO does an outstanding job in running its TIPS strategy. Mihir Worah buys TIPS plus a small parcel of non-TIPS debt to maximize returns such as mortgages and corporate bonds. Harbor Real Return (HARRX) is the cheapest version for retail investors.
PIMCO Total Return (PTTRX)
Yes, the giant of the bond world is still a great holding. Bill Gross' bet against Treasuries hasn't worked out, and some investors say that's because the fund is too big. While we are concerned about the fund's asset base, it isn't to blame for sluggish performance in 2011. The bond market has massive amounts of liquidity, so the impact of asset size is much more subtle than in equities. Retail investors should choose between Harbor Bond (HABDX) and PIMCO's new Total Return ETF, each of which charges 0.55% in expenses.
T. Rowe Price High-Yield (PRHYX)
Manager Mark Vaselkiv has done an excellent job in 15 years at this fund. He leans toward the cautious side, and that's a welcome approach, given the risks of junk bonds. Most years, including this one, the fund lands in its category's second quartile, but that adds up to top-decile results over Vaselkiv's tenure. It was closed to new investors from 2005 to 2007, but it is receiving a small amount of outflows now, so I wouldn't expect the window to close this year.
PIMCO Commodity Real Return Strategy (PCRIX)
Commodity funds are useful inflation hedges, but you have to limit them to a small portion of your portfolio because they are supervolatile. In addition, they tend to be rather inefficient from a tax perspective, so be sure to keep them in a 401(k) or IRA. This particular commodity fund has the added benefit of having a Treasury Inflation-Protected Securities kicker, so you're getting two angles on inflation protection in one fund. For retail investors we recommend Harbor Commodity Real Return (HACMX), which is a near-clone of this fund and cheaper than the retail shares of this fund.
If you'd like to track and analyze the funds mentioned above, click here to create a watch list. Then simply click "continue," name your watch list, and click "done." (If this link does not work, please register with Morningstar.com--registration is free--or sign in if you're already a member, and try again.) This will allow you to save and monitor these holdings within our Portfolio Manager.
Our Target-Date Funds
We do have target-date funds available in our 401(k), but they are custom-designed by our Ibbotson team using the funds in the 401(k) lineup. We also have a service that manages portfolios for employees based on their needs.
This article originally appeared in Morningstar FundInvestor.
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Russel Kinnel has a position in the following securities mentioned above: VWILX, SLADX, VHCOX, OAKLX, PTTRX, PCRIX, HACAX, DODFX, VASVX, POAGX, PRRIX, RWMFX, PRHYX, NEWFX, VFTNX, ODVYX. Find out about Morningstar’s editorial policies.