Popular Funds That Don't Make the Grade

Many times, investors find their way to funds we rate highly. It could be that some investors are actively seeking funds that earn Morningstar Medalist ratings. Others may be pretty savvy when it comes to evaluating funds according to the same fundamental pillars that Morningstar's manager research team looks at: People, Process, Performance, Parent, and Price.

I did a screen using Morningstar's Direct software, and I found that of the top 200 funds by net assets, about three quarters had Morningstar Analyst Ratings of Gold, Silver, or Bronze.

But there are plenty of widely held funds (with asset bases of upwards of $10 billion) that we don't rate highly. Here are a few notable examples, along with our reasoning for why we don't think they make the grade.

Lord Abbett Short Duration Income

LLDYX

Total Assets: $37 billion Morningstar Analyst Rating: Neutral

This fund has a lot going for it (including low fees, long-tenured managers, and an impressive performance record), but we can't give it our recommendation. As senior analyst Cara Esser points out, "the fund's credit-sensitive portfolio, significant exposure to structured fare, and rapid asset growth (which has slowed recently) lie behind its Neutral Process rating and Morningstar Analyst Rating of Neutral." Esser explains that the fund switched its strategy nine years ago from a short-term government bond fund to a broader mandate focused on credit-sensitive investment and junk-rated corporate bonds and asset-backed securities. The fund benefited from the timing of its strategy shift as riskier assets have rallied since the financial crisis. However, it's also more susceptible than many of its short-term bond peers to losses in a flight to quality or economic slowdown, Esser says.

Vanguard Explorer

VEXPX

Total Assets: $11 billion Morningstar Analyst Rating: Neutral

Too many changes with this fund's management and strategy dampen our conviction here. Vanguard Explorer has changed strategies several times in the past decade, shifting between quantitative and fundamental management and changing the number of subadvisors it uses, says analyst Andrew Daniels. The latest change came in January when it dismissed subadvisor Century Capital Management; this was the seventh subadvisor change since 2005. "All these changes make it difficult for investors to know what they will get going forward," said Daniels. He notes that the fund's subadvisors are solid, but it fails to distinguish itself from the benchmark.

T. Rowe Price International Stock

PRIUX

Total Assets: $14.8 billion Morningstar Analyst Rating: Neutral

Richard Clattenburg has gotten off to a solid start since he took over management of this fund 19 months ago. Indeed, senior analyst Bill Rocco notes that foreign stocks have gyrated up and down since Clatterburg took the helm on April 1, 2015, but he has handled the turbulence pretty well. He also employs the same distinctive growth strategy as his predecessor, Robert Smith, with whom he worked closely on this fund in the past. Still, Clattenburg has limited portfolio-management experience; this prevents Rocco from recommending T. Rowe Price International Stock with conviction.

Franklin Rising Dividends

FRDPX

Total Assets: $17 billion Morningstar Analyst Rating: Neutral

Fairly robust inflows since 2010 have led to a strategy shift at this fund. A comanager was added to assist manager Donald Taylor, and the portfolio has become more diffuse, too. Between mid-2010 and mid-2014, its number of holdings increased from roughly 50 to 70, while the percentage of assets in its top 10 decreased from nearly 50% to around 30%, said analyst Alec Lucas. The fund's massive size makes it difficult for it to invest in small- and mid-cap stocks. That would be less of a concern if they had never figured prominently in the portfolio, but as Lucas points out, smaller fare were a key source of outperformance during the dot-com bear market of the early 2000s, when the fund had a much smaller asset base. "All in all, the changes here combined with the proliferation of competitive dividend-growth options during the past decade warrant a Morningstar Analyst Rating of Neutral," Lucas said.

Nuveen High Yield Municipal Bond

NHMAX

Total Assets: $13 billion Morningstar Analyst Rating: Neutral

This high-yield muni fund has put up some of the most impressive returns in the high-yield muni Morningstar Category, but it's also distinguished by a very aggressive strategy, says analyst Brian Moriarty. The risks of the strategy were on full display in the liquidity-starved market of 2008, when outflows forced the fund's managers to unwind some of its leverage-inducing inverse floaters and liquidate holdings. Short exposure to Treasury bond contracts magnified losses. The fund lost roughly 40% that year, while its typical category peer lost 25%. While it boasts a number of positive qualities, such as Nuveen's robust investment team and a relatively inexpensive price tag, the fund still uses the same strategy that led to the poor showing in 2008, which could make it vulnerable in another downdraft, Moriarty said.