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Fund Spy: Morningstar Medalist Edition

Highlights From Morningstar's Analyst Rating System

Captures what backward-looking metrics can't.

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Morningstar today published a new Morningstar Analyst Rating on roughly 350 mutual funds sold in the United States. As outlined in a series of recent articles, this new system is the summary view of Morningstar analysts' assessment of a fund's strengths and weaknesses across five key pillars: People, Process, Parent, Performance, and Price. The Analyst Rating is a natural next step for the qualitative written research on funds that Morningstar has been publishing since the late 1980s.

Here are just a few of the nuggets that investors may notice about the new Analyst Ratings:

Keeping a Long-Term Perspective 
It's hard to avoid getting caught up in the latest numbers. Placing greater importance on the recent data points over historical ones, commonly referred to as recency bias, is a well-documented human tendency that can lead to poor decisions. Yet, the recent past tells you no more or less about a fund's abilities than any other time period does. That's why Morningstar fund analysts work hard to avoid recency bias in their own work and try to help investors see through the haze caused by the latest data. By examining performance in different market environments, over a manager's tenure and over rolling periods, for example, investors can better appreciate the details and context of a fund's performance over time.

Beyond slicing the numbers in different ways and over longer periods, the analysts also consider the people, process, price, and parent company. As a result, at times the Analyst Ratings can and do send a different signal than performance alone would. In some instances funds earned one of our positive Morningstar Analyst Ratings--Gold, Silver, or Bronze--even though they had a Morningstar Rating (which assesses a fund's past risk- and load-adjusted returns versus peers) of 1 or 2 stars.

And, some funds with unimpressive trailing returns rated well.  Clipper (CFIMX), for example, is Gold-rated, yet its trailing five- and 10-year returns look poor and the fund has a low 1-star Morningstar Rating as a result. The 10-year star rating does not reveal, however, that Clipper has been managed by Chris Davis and Ken Feinberg since the start of 2006. The investment process is proven with strong 10- and 15-year returns at  Selected American (SLADX) and  Davis NY Venture (NYVTX). Davis Selected Advisers is an exemplary steward of capital whose interests are well aligned with shareholders'; that shows in the low fees the firm charges for its funds, stable management, and large levels of manager investment across the funds. The team has had long-term success running a similarly concentrated approach in a separate account. And there are signs of a performance turnaround taking place at Clipper: Returns have been back on track since March 2009.

On the flip side, some funds have put forth compelling returns, but it's hard to be comfortable with the fund's profile on other dimensions. For example,  Wells Fargo Advantage Ultra S/T Income (SADIX) invests a significant chunk of the portfolio in corporate bonds, asset-backed securities, and commercial mortgage-backed securities. At the end of September 2011, the fund held a 78% stake in these sectors, which was significantly more than that of its typical peer. The team is also willing to dip into midgrade credits more than most. BBB rated bonds account for about a third of assets, which is notably more than the average ultrashort-bond fund. The fund doesn't take on much interest-rate risk and is less vulnerable to increases in interest rates. But the credit-sensitive tilt has packed its punch and returns have been good. Because most investors use ultrashort-bond funds in place of cash, though, high returns shouldn't come at the expense of safety. The fund lost 6.5% in 2008's credit crunch; that was in line with the group's average but a steep decline for any investor focused on capital preservation. We've rated the fund Negative because we're not convinced that investors will be fairly compensated for the additional risk this fund courts.

Unafraid to Be Unpopular
The Analyst Ratings don't always line up with what investors are buying and selling. Investors have been rushing the exits at Silver-rated  American Funds Growth Fund of America (AGTHX), for example. Growth Fund of America was investors' darling following the 2000-02 bear market and saw huge inflows in the middle of the decade. Its relative performance has since moderated. The fund has been in its category's bottom quartile over the past three and five years, and much of its investor base has jumped ship. Even so, we think the fund's fundamental case is still strong because of its experienced team, staid process, and low costs. Growth Fund of America earns a positive Silver rating to reflect our view that it remains a competitively advantaged investment.

Forward-, not Backward-Looking
If a fund's process or risk profile changes, it can affect its rating. For example, DoubleLine Total Return Bond (DBLTX), managed by Jeffrey Gundlach, has really sparkled since it launched in 2010. The fund has posted outstanding returns, paid one of the highest yields in its peer group, and has been resilient when markets turned choppy. Yet, Gundlach is employing his heretofore successful process differently today than when he was at TCW; the portfolio is steeped in esoteric securities that have histories of suffering in market panics regardless of their fundamentals. Stated more simply, though the fund's positioning has worked in its favor thus far, it carries more risk than before. That is more complexity and risk than one would normally expect from a core, intermediate-term bond portfolio and is the primary driver behind the fund's Analyst Rating of Neutral. 

Material Changes Matter
Morningstar fund analysts have always kept tabs on developments in the fund industry that have an impact on whether or not a fund is a compelling investment. Some news is clearly material to a fund's future.

For example,  Fidelity Magellan's (FMAGX) recent manager change factored into that fund's Analyst Rating. The new manager, Jeffrey Feingold, has been successful running  Fidelity Trend (FTRNX) since 2007. He's shown promise, and we view the change as a necessary and welcome step, but Magellan is about 15 times larger than his current charge. It's tough to tell whether Feingold can translate his style to a much larger stage, so that's one key reason we've given the fund an Analyst Rating of Neutral.

To see the Morningstar Analyst Ratings, read supporting analyses, and learn how funds stack up across the five pillars, visit We have roughly 350 Morningstar Analyst Ratings available today and will continue to publish new ratings and accompanying research daily as we ramp up to approximately 1,500 funds by the end of 2012.

Karen Dolan does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.