The Big Tent That Is the Neutral Rating

We give more Neutral ratings than any other Morningstar Analyst Rating. That makes sense because a Neutral-rated fund is one where there isn't sufficient evidence to believe it will produce superior long-term risk-adjusted performance. If we rated every single fund, the Neutral camp likely would be the largest--so many funds fit into that description. The Morningstar Medalists (those rated Gold, Silver, and Bronze) are three shades of recommended funds and account for fewer than 10% of the more than 7,100 open-end funds available in the U.S. marketplace. Negative funds are not recommended. There are quite a few different flavors of Neutral, so I'll walk you through each one with some examples.

The Unknown
For a lot of funds, there's just not enough information to warrant a positive rating. New managers with no prior track records fit here, as do funds with new strategies. When we first hear about changes, we may talk with the new managers, but we can't be sure how they'll execute their strategies until we've seen a few portfolios. Even after a year or so, we still might not have much of a track record to go on.

For instance, we rated  Fidelity Equity-Income (FEQIX) and  Fidelity Equity Dividend Income (FEQTX) as Neutral a little more than a year after both made manager and strategy changes. Fidelity wanted to emphasize the dividend part of its equity-income funds, which had previously lost interest in income. So, these changes made a lot of sense, but there are other equity-income funds with proven managers and strategies. At Fidelity Equity Dividend Income, new manager Scott Offen aims for a yield that is 1.5 times the S&P 500's. Offen had a decent, though not outstanding, record at his previous charge, Fidelity Value Discovery (FVDFX). However, Fidelity Value Discovery ran a more freewheeling value strategy compared with his new straightforward emphasis on dividends. So, even though Offen isn't new to managing, he's pretty new to the strategy. Thus, we don't have enough to recommend it.

Manager changes at  Meridian Growth (MERDX),  Janus Global Select (JORNX),  Legg Mason Capital Management Value (LGVAX),  Laudus Growth Investors U.S. Large Cap Growth (LGILX), and  Columbia Value and Restructuring  spurred us to rate the funds Neutral. In cases like Columbia Value and Restructuring and Janus Global Select, the new managers have track records, but with different strategies than the ones they employ today. So, we want to know more about their new strategies and see whether they can add value with them. The new managers at Laudus Growth Investors were promoted from the analyst ranks; the strategy likely won't change, but we don't know if they will have the skills of their predecessor. At a minimum, they lack his experience.

Big Positives and Big Negatives
Sometimes, it's not so much a lack of information as it is some strong signals in both directions canceling each other out. For example,  CGM Focus  has a very experienced manager in Ken Heebner and top-percentile returns for the trailing 10- and 15-year periods. Heebner practices an extremely aggressive style that involves fast moves in and out of sectors and even bold short bets against a stock or an industry. Most recently, Heebner went 15% short on Treasuries. But here's the catch: Heebner is in his 70s, and he doesn't appear to have much backup. Given the extreme risks, it really makes sense only if you can make the fund a holding for more than 10 years, and it's awfully tough to say who will be running the fund in 10 years. For shorter periods, there's no telling what the fund will do. Its five-year returns are the worst in its category.

 Marsico Focus (MFOCX)  is another case where the long-term returns were good, the recent term is weak, and the team is in flux. Tom Marsico runs a focused growth strategy that is riskier than most funds, though not in CGM's league. The story isn't as dramatic as CGM's, either: Performance is less extreme, the firm has other analysts and managers. However, a bout of poor performance led to sizable outflows and a slow exodus of portfolio managers and analysts, including Doug Rao, who was a comanager of this fund. Seven analysts have left the firm since 2010, thus raising concerns about the fund and the parent. Since the beginning of 2011, the firm hired nine new analysts with varying levels of investment experience, resulting in a total of 12. While Marsico has taken a number of steps to stabilize the team and the firm, it's not yet clear those steps or the new hires will result in sustained, improved performance. 

Unimpressive Strategies
Funds that don't have a proven advantage also can wind up stuck in Neutral. Funds with flawed strategies and middling results are likely to earn this rating.  American Funds American High Income Trust (AHITX) fits this bill. The once-appealing fund has a bloated $21 billion asset base, credit quality that has declined to the category average, and a team of independent managers who can sometimes override each other's bets. Performance has likewise declined from a former peak.

 Brandywine (BRWIX) and  Brandywine Blue (BLUEX) also have suffered long bouts of underperformance. We might be willing to bet on a rebound if we had more faith in the strategy behind these funds. The idea is to beat the market by using an army of analysts and contacts to discover potential market-moving news, such as a change in sales patterns, the appeal of a new product, or a positive earnings surprise. After the anticipated news comes out or doesn't, the funds move on to the next thing. The problem is that information moves very quickly, and scores of sell-side analysts are quite good at doing the same thing. Thus, we don't see a sustainable edge at these funds.

Proven Mediocrity
Sometimes it's just a matter of summing up a record.  Pioneer Fund (PIODX) has been run by John Carey since 1986, and the fund's cumulative return since then is 867%, compared with 1,067% for the S&P 500. That's a big pile of evidence that there are more-skilled managers out there. The 10- and 15-year records are likewise mediocre versus peers and the benchmark.

 Permanent Portfolio (PRPFX) has a fine record, so why am I including it here? The manager actually has a poor history of security selection as three other funds that he runs have average to poor records. It's really just the fund's allocation mix that has worked for it, and you can easily build a similar portfolio of exchange-traded funds and save a bundle on fees. Finally, the firm has only one analyst. That must make it extremely profitable for management, but I don't see why you'd want to invest there.

It Doesn't End Here
We have at least six ratings-committee meetings a week, often meeting for an hour and a half or more each day. We review funds that already have been rated, as well as some that haven't. We aim to keep an open mind to new evidence, though our focus is on long-term fundamentals rather than recent results.

For a list of the open end funds we cover, please click here.
For a list of the closed-end funds we cover, please click here.
For a list of ETFs we cover, please click here.
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