The low-cost Vanguard Large Cap Value Index makes Gold, and TIAA-CREF Large-Cap Value earns a Bronze for outperformance. Meanwhile, a manager change knocks Calamos Market Neutral Income down a notch.
Christine Benz: I'm Christine Benz for Morningstar.com.
Two large-cap stock funds recently became Medalists, while a market neutral fund got a downgrade. Joining me to discuss recent ratings changes is Russ Kinnel, director of manager research for Morningstar.
Russ, thank you so much for being here.
Russ Kinnel: Good to be here.
Benz: Russ, you want to talk about a few different funds that have seen rating changes recently. But first, let's just talk about the Analyst Rating system. How is it different from our star rating system?
Kinnel: The Analyst Ratings are forward-looking fundamental-driven ratings, whereas the star rating is a quantitative measure of past risk-adjusted performance.
The star rating is purely quantitative; we have no input on it. Whereas the analyst rating is entirely the work of our analyst staff going out, talking to managers, doing research, trying to figure out which funds have the best long-term prospects. They care about things like the parent company, expense ratio, the manager's strategy--all those things. It's fundamentals-driven.
Benz: The goal there is to help steer investors to funds that we think over a reasonable time period, say a full market cycle, should outperform their peers?
Kinnel: That's right. We're not making market calls. We're saying, if you want a large-growth fund, this is one of the best, or this one is not. It's much more about the fundamentals within that category.
Benz: Let's talk about the first one, Vanguard Large Cap Index. It just got a rating, and it came out as Gold. Let's talk about the thesis for this particular fund.
Kinnel: It follows the CRSP Large Cap Index. It's got about 650 names. It charges 9 basis points on the Admiral shares--very low cost. In many ways, it's not too different from a Vanguard 500, and you have all those good things going for it that Vanguard 500 has. A cap-weighted index, low cost, low turnover, big core holdings for your portfolio.
Benz: For people who already have the 500 index, there is probably no need to swap into this one, but for people who are building a portfolio anew, why would they perhaps select this one versus say the 500 index?
Kinnel: As you say, they are very similar, especially in performance and fees. So, you certainly wouldn't make a swap or own both of them, but there is some value to it. One, it's little wider. It goes a little deeper into mid-caps. It's also complementary to Vanguard Small Cap, which follows the Vanguard CRSP Small Cap Index.
So, if you already have the small-cap index, you might want this as the fitting pair, but it is pretty similar with the S&P 500.
Benz: You could cover the whole market if you had those two pieces?
Kinnel: That's right.
Benz: Let's talk about the next fund, TIAA-CREF Large-Cap Value. We recently moved it up to Bronze. It had been at Neutral. What gave you and the team a little more conviction in this fund and made you want to upgrade it?
Kinnel: It's kind of a boring fund that doesn't have a very high active share. It's got a high R-squared, with a fairly diffused portfolio of nearly 200 names.
But when you step back and look: The manager Richard Cutler has been there since 2002, and over that time, the fund has beaten its peer group and the index by a decent amount. He is clearly adding value, and it was kind of a matter of just stepping back and saying, he has been consistent enough, even though it's not a fund that stands out as a really focused or bold fund. It's still a good fund where he's just incrementally added some value.
Benz: One question I think people might have: You noted that performance has been pretty good, so why upgrade it now? People might say, why didn't you do that a couple of years ago if you thought this was a decent manager?
Kinnel: Well, I think it's a matter of getting comfortable with the manager. Each year is an additional year of evidence. It's not a thrilling strategy. He runs a deep-value strategy with a catalyst, which is not extreme. The fund did lose a little more in the 2008 bear market, so that was obviously another thing keeping us from raising it before. But there have now been enough years that we can look at it and say, well, this is really good record. Yes, it had a weak '08, but the overall weight of the record is strong. So, even though it's kind of boring, it's still a pretty good fund.
Benz: I know a lot of people are familiar with CREF due to its presence in the retirement plan market especially for college professors and other people in education. But is this particular fund available to retail investors? If I wanted to just go out and buy it for myself, even though I'm not a teacher?
Kinnel: It is. And the retail share class, depending on what channel you're going through, costs about 80 basis points. The institutional is about 45. So, it's pretty low cost. It is accessible in a lot of different channels, but as you say, the vast majority of money that TIAA-CREF is running is for 403(b)s and plans like that.
Benz: Let's take a look at the next fund. This is the fund that we downgraded from Bronze to Neutral, Calamos Market Neutral Income. Let's talk about the negatives for this fund and what prompted the downgrade.
Kinnel: Manager Christopher Hartman has left Calamos, and there have been a number of other departures at Calamos. We always start to get worried when we see the pace of departures accelerate at a firm, because a fund is never just one person. It's a number of people, both managers and analysts, contributing to its success, and so when you see that pace accelerate as well as a lead manager leave, that gives us some concern.
Eli Pars is the new manager. He is an experienced investment professional, but we don't have much of a track record on him. So, it's definitely a worry.
Benz: Let's talk a little bit about this particular strategy, because it is a very specific sort of strategy. First of all, what is market neutral, and then what is this fund's specific spin on market neutral?
Kinnel: Market neutral includes a bunch of different strategies. It's really about the goal rather than the process; that's the way we would characterize this category. These are funds that should, as the name implies, not be affected by the market. They're trying to do some kind of strategy that will move in a different fashion from the market, and should make you money, a small amount of money, in up years and down years alike.
There are a few different strategies--some are arbitrage strategies, others are doing something different, but they're all just trying to make a modest sum every year.
Benz: And this particular one uses what's called a convertible arbitrage strategy. That's a complicated strategy, but can you briefly shorthand what goes on here?
Kinnel: The basic idea of convertible arbitrage is to find mispriced convertibles, and if you find, say, a convertible bond that's priced cheaply, you can lock in that mispricing by shorting the stock and going long the convertible bond. What that means is, now the market doesn't matter too much because you are shorting the stock, but if you're right, and that bond is underpriced, then you're going to gain the difference in that, and the convertible bond should appreciate more or have a greater total return than the stock. It's a pretty good strategy, and I like it. It can produce pretty good returns over time.
Benz: Taking a step back, Russ, when you look at the alternatives group in general, there has been a lot of asset growth in this area. What's your take on this space? Do most people need these types of products? I know there is a huge gradation, but how should people navigate and think about this area?
Kinnel: I think there are a lot of attractive options in alternatives. However, the vast majority of them are high-priced and not really worth your money. So, you have to be a very choosy investor.
No one needs to have alternatives, but one of the appeals is that a lot of alternatives can have exposure to areas that move differently from stocks and bonds, so there is a nice diversification component.
It's interesting if you look at market neutral's returns. Over the past five years they've returned 1.5% compared with short-term bonds returning 3%. So that illustrates the challenge there--a lot of them have very meager returns, and combined with high fees, it's not very attractive, so you have to be very selective.
We do have Medalists in most of the alternative categories, but you have to look pretty closely, and you have to understand the strategy well enough to use it correctly. I think a lot of alt strategies come out and people think, "This is a free lunch. It's going to make me money in down markets and in up markets. It's going to make a killing." And it's rarely that simple. So, you really need to know the strategies.
Benz: Russ, thank you so much for being here.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.
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