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Fund Spy: Morningstar Medalist Edition

Slumping Medalists Are Sometimes the Best Bets

Our favorites can go from dogs to swans.

"How can a fund with as poor performance as  Vanguard Precious Metals and Mining (VGPMX) earn a Gold rating?"

"Why do you give a Silver to  Janus Overseas (JAOSX) despite terrible five-year returns?"

It may appear we're ignoring evidence refuting our ratings. I get an email along these lines every couple of days. But the emails I get today are nothing like the complaints I received about recommending Bill Nygren's  Oakmark (OAKMX) and  Oakmark Select (OAKLX) a few years ago.

I understand the questions, but five-year returns are not as telling as we all wish they would be. That's particularly true for funds that have big biases relative to their category peers. Vanguard Precious Metals and Mining invests in gold stocks like its peers but also in diamond, copper, and potash miners. As a result, the fund's performance relative to its category really tells you how those industries are doing relative to gold rather than whether manager Graham French is doing a good job. In fact, five years ago Vanguard Precious Metals and Mining was in the top percentile for its peer group, thus illustrating my point.

While this fund's biases are a little more extreme, it's really true of a lot of funds. A typical equity fund may have a much different sector or market-cap profile than its peers. Focused funds can rally or plummet on just a few holdings, as funds like Oakmark Select have shown. A bond fund might have significantly lower duration or higher credit risk than most others in its category. As all of these factors go in and out of favor, a fund's returns will bounce up and down. We try to adjust for those factors to see whether a manager is really adding value. 

I pulled out the June 2008 Morningstar FundInvestor to look at what funds were Fund Analyst Picks (the precursor of our Gold rating) but had bottom-decile five-year returns. There were five:  Clipper (CFIMX), Oakmark Select,  Fidelity Dividend Growth (FDGFX),  Weitz Value (WVALX), and  Ariel Appreciation (CAAPX). Four out of those five produced top-decile returns over the ensuing five years, and one, Clipper, was just a hair below the category median. Overall, their average performance ranking was in the top 15% for the past five years.

What about the Analyst Picks that were top-decile for the past five years in June 2008? The results are pretty good but not as good as the hated five's. The 15 in the top decile produced an average performance ranking of 31.5% in the ensuing five years. That's still pretty good. Three of the 15 were top-decile:  TCW Total Return Bond (TGLMX),  T. Rowe Price Global Stock (PRGSX), and  Oppenheimer International Growth (OIGAX). However, three were bottom-decile over the next five years:  Schneider Value , Vanguard Precious Metals and Mining, and  Thornburg Value (TVAFX).

Looking for more contrarian ratings plays you can make today, there's Janus Overseas. The fund has a distinct bias toward India that has made it swing dramatically. Like Vanguard Precious Metals and Mining, it could be a good contrarian bet. 

 FPA New Income (FPNIX) is another Silver-rated fund with poor five-year performance that could bounce back. The fund is run to the conservative side of non-traditional-bond funds as well as its old peer group in intermediate bond. Tom Atteberry is focused on avoiding losses. His goal is beating the Consumer Price Index by 100 basis points a year. So, he's not trying to make big bets on market direction. Rather, he's trying to avoid big bets. If everything goes swimmingly in bond land, the fund may well look humdrum, but if things hit the fan, it ought to provide solid protection.

 Artisan Small Cap Value  is rated Gold but has been stuck in the doldrums. Scott Satterwhite and team have done a fine job over the long haul but some names, particularly in energy and technology, have held the fund back. The team still has a strong record here and at other funds, however.

Finally, the 1-star Silver-rated  Royce Low Priced Stock  has suffered from Whitney George's fondness of materials stocks. A rebound in the world economy could give this fund a nice snap back.

This article previously appeared in the July issue of Morningstar FundInvestor.

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