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Fund Spy: Morningstar Medalist Edition

March Ratings Activity Features a Flurry of Downgrades

Two prominent Gold-rated funds were downgraded.

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In March, Morningstar manager research upgraded the Morningstar Analyst Ratings of five funds and downgraded 11. Analysts also assigned 10 new fund ratings. The table below lists all the changes, and some notable ones are highlighted here.

 ClearBridge Appreciation’s (SHAPX) record of downside protection, experienced managers, and below-average fees inspire confidence that it will continue to outperform over a full market cycle. It is a great fund for cautious investors and was upgraded to Silver from Bronze.

Managers Scott Glasser and Michael Kagan have run the fund together since early 2010, and they focus on downside protection and modestly beating the S&P 500 benchmark with less risk. The managers want to be long-term owners of stocks where the potential upside outweighs the potential downside by a ratio of 3 to 1. Some of the fund’s largest holdings have been in the portfolio since as early as 1986, such as  Microsoft (MSFT) and  Walt Disney (DIS). It has one of the better risk/reward profiles in the large-blend Morningstar Category.

 Sequoia (SEQUX) was lowered to Bronze from Gold following manager Bob Goldfarb’s resignation and revisions to the fund’s process. Goldfarb stepped down as comanager following the implosion of  Valeant Pharmaceuticals (VRX), which at one point in 2015 amounted to more than 30% of the fund’s assets. Although this isn’t how the firm envisioned Goldfarb’s retirement, it had been preparing for it for years, having added six analysts to the 12-person team during the past decade. Despite the Valeant disaster, this fund still has strengths. David Poppe is an experienced investor with talented analysts supporting him. They plan to stick with the same approach, albeit with an increased emphasis on risk control, which could change the fund’s character. Concentration brought risks, but it also was a key to the fund’s strong returns.

 Longleaf Partners (LLPFX) was downgraded to Neutral from Silver as severe performance woes stemming from missteps with some heavily weighted stocks highlighted the risks of investing in this concentrated fund. The managers frequently take near-10% stakes in their highest-conviction holdings. The stunning decline in oil and gas prices hit such large holdings as  Chesapeake Energy (CHK) and  Consol Energy (CNX) hard. In addition, China’s sweeping anticorruption drive and slowing economy pummeled  Wynn Resorts (WYNN). The managers stuck with large holdings Chesapeake and Dell for years as they endured problem after problem--the recoveries never arrived.

This fund will perform well when energy prices rise or as other trends the managers forecast come to fruition. The managers remain insightful, their analyst team stable, and Southeastern’s strength as a parent impressive. But a fund that repeatedly makes serious errors among its heavily weighted holdings will struggle to outperform over time.

New Ratings
 FMI International (FMIJX) starts off with a Morningstar Analyst Rating of Silver because of its seasoned team, patient and cautious approach, and below-average fees.

The fund has posted exceptional results since its inception approximately five years ago. Its 9.2% annualized gain from January 2011 through March 2016 beats 98% of its foreign large-blend peers. Currency tailwinds have benefited the fund, which fully hedges its non-U.S. currency exposure to the dollar.

Lead manager Pat English and team take a long-term, “business owner’s” approach to investing. They focus on non-U.S. firms that have strong recurring revenues, balance sheets, and returns on invested capital, with share prices trading at discounts to their intrinsic value estimates.

The resulting portfolio is concentrated and can hold more cash--currently about 20% of assets--than its typical peer. This approach has achieved a superb record with strong downside protection--a hallmark of FMI funds. Currency tailwinds won’t last forever, but this patient approach should deliver for long-term investors.

While  Baird Aggregate Bond (BAGIX) inhabits a well-trodden investment-grade landscape, management’s experience, nimble implementation, and low fees give it an edge, delivering consistent returns to investors. Thus, this fund starts with a Silver Analyst Rating.

Mary Ellen Stanek helms a team of six named comanagers who average 32 years of industry experience. The team is rounded out with five additional senior portfolio managers and four analysts. The team invests in a mix of corporates, mortgages, and Treasuries, and it benchmarks itself against the Barclays U.S. Aggregate Index. Emphasis has been on higher-quality holdings, and the fund tends to have a higher allocation to A and BBB rated securities and a lower allocation to non-investment-grade or nonrated securities than its typical intermediate-term Morningstar Category peer.

Historical performance has been impressive. Over the trailing 10 years ended March 2016, the fund generated an annualized return of 5.2%, modestly ahead of the index and better than 77% of its peers.

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Andrew Daniels has a position in the following securities mentioned above: BHC, MSFT, DIS, FMIJX. Find out about Morningstar’s editorial policies.