10 Under-the-Radar and Up-and-Coming Funds

A version of this article was originally published in the first-quarter 2016 edition of Morningstar Prospects, which highlights promising managers that Morningstar Manager Research analysts currently do not cover but may cover in the future. The full list and publication are available to subscribers of Morningstar Direct.

We added an exchange-traded fund for the first time to Morningstar Prospects earlier this year. ETFs have always been eligible for the list of up-and-coming or under-the-radar investment strategies that Morningstar Manager Research thinks might be worthy of full coverage someday. Many ETFs, however, track common indexes, follow strategic weighting schemes that don't have long track records outside of product development laboratories, or are unattractively priced relative to rival ETFs.

Goldman Sachs ActiveBeta U.S. Large Cap Equity ETF GSLC could be different, though. This rules-based active strategy tries to edge the S&P 500 by leaning slightly toward profitable benchmark constituents that exhibit low valuations and volatility but also show some relative price momentum. It ends up owning most of the benchmark and should track it closely. Even if it doesn't beat traditional S&P 500 funds in absolute terms, Morningstar's Director of North American Passive Strategies Alex Bryan thinks it can deliver better risk-adjusted results over time. The ETF's 0.09% expense ratio is less likely to erode whatever modest performance advantage it might offer.

Here are summaries of other recent new additions to Morningstar Prospects.

It's Academic AQR Long-Short Equity QLEIX is one of several alternative strategies in AQR's lineup that rely on academic theory and AQR research. AQR Long-Short Equity attempts to mine several factors--such as momentum, value, and tactical beta--in a three-pronged approach that uses those factors for security selection, passive market exposure, and tactical market exposure. The goal is to separate the returns derived via market exposure, or beta, from returns generated from the skill of long and short security selection. The fund has posted impressive returns since its July 2013 inception, gaining 15.2% from July 16, 2013, through the end of June 2016 versus 1.5% for the average long-short equity fund.

Going With the Mo LoCorr Market Trend LOTIX is subadvised by Graham Capital Management, which has been running this managed-futures strategy in a hedge fund since 2006. Like other managed-futures funds, this strategy seeks to profit from momentum, the idea that winners will keep winning and losers will keep losing. The strategy systematically trades based on nine different timing signals, which range from the short term (one month) to the long term (12 months). The more agreement there is among the signals in terms of direction, the more conviction the strategy will have in the trade and the larger the bet will be. Management has installed some risk measures to try to protect against trends turning against the fund. The longer a trend has lasted, for example, the less conviction there will be in the bet. The average trade lasts 55 days. The fund is also broadly diversified. It trades more than 50 markets across stock, currency, fixed-income, and commodities. The fund's volatility target is 12%, which is slightly higher than the norm in the Morningstar Category. A 12-person research team supports the strategy.

Veteran in Charge

American Century's Phil Davidson leads AC Alternatives Market Neutral Value ACVKX using the same consistent and time-tested approach employed at his three long-only value funds with Morningstar Analyst Ratings of Silver, including

No Small Thing

There are ample grounds to be hopeful about Columbia Acorn Emerging Markets' CATIX long-term prospects. This fund, which is available in several share classes, focuses on small and midsize companies that are based in the developing world or have considerable business or assets there, and its advisor, Columbia Wanger Asset Management, has a long and successful history of investing in smaller caps abroad. This fund uses the same quality-oriented and valuation-conscious growth strategy as Silver-rated

A Healthy Mix Rainier International Discovery RAIIX, which is available in two mutual fund share classes as well as a separately managed account and a collective investment trust, has an experienced and talented skipper at the helm. Henrik Strabo, who serves as the head of international investments at Rainier Investment Management as well as the manager of this strategy, has more than three decades of foreign-equity experience, and he did a good job earlier in his career during his tenures as the international CIO at American Century Investments and as a manager on that firm's foreign small/mid-growth fund. Strabo, who is supported by two fairly seasoned analysts, favors strong growers that have superior competitive positions, strong financials, and good corporate governance as well as attractive valuations. He readily invests in emerging-markets stocks that meet his standards, but he also focuses further up the market-cap ladder than most of his peers and pays ample attention to risk controls, so the strategy has a healthy mix of bolder and tamer traits. Strabo has led the mutual fund to superior total and risk-adjusted returns since it opened in late 2012. The expense ratios on the two share classes of the mutual fund aren't too bad, given that the strategy's asset base is still small. Finally, Manning & Napier's pending acquisition of a majority share in Rainier should not have any impact on the day-to-day management of the strategy.

Southern Comfort Queens Road Small Cap Value QRSVX has earned one of the strongest risk-adjusted records in the small-cap value category over the past decade, but it still has less than $200 million in assets. Manager Steven Scruggs has run the fund since its 2002 inception, and since 1999 he has been an integral part of advisor Bragg Financial Advisors, a family-owned firm in Charlotte, North Carolina. Scruggs is supported here by an investment committee including Benton Bragg, the firm's president, and Matt DeVries, who joined the firm in 2015. They look for stocks worth holding for the long term--turnover has been in the single digits--and so seek companies with solid management in growing industries that also boast strong balance sheets and sell at a margin of safety to intrinsic value. The portfolio is relatively concentrated at 50 to 60 holdings, but individual holdings are generally under 5%. It is reasonably diversified across sectors, though its profile is distinctive relative to the category and benchmark Russell 2000 Value Index, with significantly more in industrials and technology and less in financials and real estate. The fund has lagged peers during more-speculative rallies such as 2013 but also led in downturns, thanks in part to its tendency to carry a large cash stake. Scruggs aims to minimize taxes, and the fund's strong trailing returns look even stronger relative to the category after taxes. While the fund's asset base is quite small, its expenses are average for a no-load small-cap fund.

Highly Flexible JPMorgan Global Allocation GAOSX uses a highly flexible investment approach: Stocks and bonds can each take anywhere from 10% to 90% of assets, and cash can grow to 80%. Nine underlying J.P. Morgan strategies that span various asset classes and geographies form the core of the portfolio. The team uses futures contracts to implement its tactical views, which can result in leverage; the fund's net exposure has ranged from roughly 80% to 120%. That said, the fund does operate within some guardrails: The portfolio must keep at least 40% of assets in international securities, and the managers aim to roughly match the volatility of a custom benchmark consisting of 60% MSCI World Index/40% Barclays U.S. Aggregate Bond Index. Jeff Geller, CIO of the firm's multiasset solutions team in the United States, serves as lead manager and receives support from four other team members. Geller oversees various strategies at the firm, including the JPMorgan SmartRetirement target-date series, which receives a Silver Analyst Rating and which won Morningstar's 2014 Allocation Fund Manager of the Year award. Well-regarded managers, including Jonathan Simon, run some of the underlying strategies, while others are run by skippers who lack public track records.

Broad Diversification

T. Rowe Price Global Allocation RPGAX provides broad diversification across asset classes and regions. Lead manager Charles Shriver targets a 60% stock/30% bond/10% alternative investment allocation and aims to keep about 40% of assets invested overseas. The portfolio's allocations don't change dramatically, though Shriver can make modest sub-asset-class shifts to take advantage of attractively valued pockets of the market. A 13-member asset-allocation committee, which includes Shriver, informs those tactical tilts based on qualitative, fundamental analysis. Seventeen T. Rowe Price strategies, including core strategies as well as more-specialized ones, such as international small cap, emerging-markets local-currency debt, and covered calls, fill out the fund's equity and fixed-income allocations. Blackstone manages the alternative allocation using a fund–of-hedge-funds strategy. Shriver is an experienced investor; he also manages Silver-rated

Social Bonds CRA Qualified Investment CRANX is run by Community Capital Management, a firm that specializes in managing environmental-, social-, and governance-focused fixed-income portfolios. CRA Qualified Investment was originally launched to help banks meet the requirements of the Community Reinvestment Act of 1977, which mandates that banks make capital available to the low- and moderate-income communities in which they serve. The fund is able to further those goals by keeping at least 90% of its assets in investments that meet CRA criteria. It furthers that goal by investing primarily in a subset of single-family and multifamily loans that qualify under the CRA based on income ranges of their borrowers and are pooled and issued as government-agency mortgage-backed securities. The firm is able to screen and choose loans to its liking and use them to create custom pools for the agencies to securitize and guarantee. It attempts to target loans with lower loan balances, typically in the $150,000 to $200,000 range, because they usually experience prepayments at a slower speed than market averages, thereby making performance more stable and predictable among the mortgage securities in which they are pooled. The fund's overall goal is to generate more income than the Aggregate Index while carrying less interest-rate sensitivity than that benchmark.

Leo Acheson, Alex Bryan, Josh Charlson, Eric Jacobson, Jason Kephart, Laura Lallos, Bill Rocco, and Gretchen Rupp contributed to this report.