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Fund Spy: Morningstar Medalist Edition

December Ratings Activity in U.S. Driven by High-Yield Concerns and Manager Departures

Downgrades abound.

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December was a busy month, as Morningstar manager research analysts in the United States downgraded the Morningstar Analyst Ratings of 10 funds, upgraded the ratings of three others, rated two funds for the first time, and re-initiated coverage of three funds.

Some notable changes are highlighted here; a complete list can be found in the table below.

The rating of  BlackRock Total Return (MDHQX) rose to Silver from Bronze following the firm’s efforts to reduce the fees of this intermediate-term bond fund. BlackRock enacted a fee waiver that expires in early 2017 (we’ll revisit the rating if fees rise after that). The fund already boasted a large, experienced team (led by Rick Rieder, who’s helmed the fund since 2010), a prudent and wide-ranging strategy, and solid execution, which has led to strong returns without undue volatility.

 Diamond Hill Long-Short (DIAMX) has also been upgraded (to Bronze from Neutral) because of lower fees, as well as our increased comfort with a 2014 management change. (We’d downgraded the rating to Neutral from Bronze at that time.) Chuck Bath, who had served as the lead manager on the fund’s long equity portfolio, stepped off in 2014 to focus on his other charge, Gold-rated  Diamond Hill Large Cap (DHLAX). Chris Bingaman, the firm’s president, who had served as the backup manager since 2007, took Bath’s place. Although Bingaman doesn’t have much of a track record, the firm’s consistency of approach across its lineup (two other funds besides Diamond Hill Large Cap earn Gold Analyst Ratings as well) and the strength of its centralized research team underpin our confidence in this fund.

The Analyst Rating for  TIAA-CREF Bond (TIBDX) rose to Bronze from Neutral, as we believe manager and process changes put in place in 2011 have borne fruit. At that time, Joe Higgins, the firm’s co-head of credit research, became the fund’s lead manager and the fund was given more freedom to invest in high-yield and non-U.S. securities. Solid results on Higgins’ watch, along with team stability, led to the upgrade.

The meltdown and abrupt closure of Third Avenue Focused Credit (which Morningstar last rated in early 2013, giving it a Neutral) due to tanking distressed-debt positions in the energy sector prompted a reevaluation of several other funds because of related concerns.  Fairholme Focused Income (FOCIX) was downgraded to Neutral from Bronze because of its highly concentrated portfolio and big stakes in distressed, less-liquid debt.  Franklin High Income (FHAIX) was downgraded to Neutral from Silver because of concerns over poor risk management, the less-liquid nature of some holdings, and heavy exposure to commodities. Conservative-allocation fund  Franklin Income (FKINX) had its Morningstar Analyst Rating placed Under Review, as the $80 billion fund holds a big stake in high-yield bonds and has also seen substantial outflows amid poor recent performance. Finally,  Third Avenue Real Estate Value (TAREX) was downgraded to Silver from Gold, not because of liquidity concerns or high-yield exposure but turmoil at its parent firm as a result of the implosion of Third Avenue Focused Credit. Third Avenue’s Parent rating was downgraded to Negative from Neutral.

 Thornburg International Value (TGVAX) announced that longtime manager Bill Fries will step off the fund at the end of 2016. That impending loss, combined with the 2014 departure of comanager Wendy Trevisani, prompted a downgrade of the fund’s Analyst Rating to Neutral from Bronze. Fries, who will remain at the firm as a senior advisor and analyst, has comanaged the fund since its 1998 inception, was its sole manager for the first eight years, and previously won Morningstar’s International-Stock Fund Manager of the Year award.

The rating of  Vanguard Energy (VGENX) was placed Under Review in November when the firm announced that Karl Bandtel, the manager since 2002, will retire in June 2016. We subsequently rated the fund Neutral; it was previously rated Gold. Although Bandtel’s successor, Greg LeBlanc (added as a comanager in November) is experienced, he doesn’t have a track record on a public mutual fund, and his record at energy-focused separate accounts is mixed.

The Analyst Ratings of  Waddell & Reed Core Investment (UNCMX) and  Ivy Core Equity (WCEAX), funds that are run in a virtually identical fashion by managers Erik Becker and Gustaf Zinn, were downgraded to Neutral from Bronze. The duo has managed both funds since 2006 using a mix of macroeconomic themes and bottom-up stock-picking. Missteps in recent years have dented the funds’ records, and the uncompelling strategy and the Negative Parent rating of Waddell & Reed (which also sells the Ivy funds) leave the funds with little appeal.

New Ratings
We re-initiated coverage of  T. Rowe Price Tax-Free Income (PRTAX) and  T. Rowe Price Tax-Free Short-Intermediate (PRFSX) with Gold Analyst Ratings for each. While the funds have different lead managers--Dino Mallas and Charles Hill, respectively--each relies on the same crew of veteran credit analysts. The two funds employ similar strategies as well: a straightforward, research-intensive tack that takes modestly more credit risk than their typical category peers while steering clear of both more-troubled areas such as tobacco as well as derivatives such as inverse floaters to boost yield. (T. Rowe Price Tax-Free Short-Intermediate invests in debt with shorter maturities than T. Rowe Price Tax-Free Income.) Both funds have generated strong results, particularly on a risk-adjusted basis, over the long haul, and both sport a significant cost advantage over their typical rivals.

For a list of the open-end funds we cover, click here.
For a list of the closed-end funds we cover, click here.
For a list of the exchange-traded funds we cover, click here.
For information on the Morningstar Analyst Ratings, click here.

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