5 Under-the-Radar and Up-and-Coming Funds
A wide-ranging menu of strategies.
A version of this article was originally published in the third-quarter 2017 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.
Morningstar Prospects--a list of up-and-coming or under-the-radar investment strategies that Morningstar Manager Research thinks might be worthy of full coverage someday--added eight new strategies in the third quarter of 2017. Here's a look at five of them.
Cheap Exposure to Investment-Grade Corporate Bonds
Goldman Sachs Access Investment Grade Corporate Bond ETF (GIGB) provides rules-based exposure to the U.S.-dollar-denominated investment-grade corporate bond universe.
The fund's underlying index, the Citi Goldman Sachs Investment Grade Corporate Bond Index, includes investment-grade corporate bonds that have a minimum of one year to maturity and are rated at least BBB- by Standard & Poor's or Baa3 by Moody's. Also, the issue must have a minimum of $750 million outstanding and a minimum issuer size of $2 billion to be part of the index's investable universe.
Issuers are first grouped into three broad industry groups: financials, industrials, and utilities. Within each industry group, issuers are ranked based on an equal weighting of two fundamental factors: operating margin and leverage. Subsequently, the index is constructed by including the highest-ranking eligible securities in each industry group, screening out the lowest-ranked eligible securities.
The index is rebalanced monthly on the last business day of each month to account for changes in maturities, corporate actions, or ratings migration; and quarterly to account for updates to the constituent securities based on the aforementioned fundamental factors. The fund's fee of 0.14% is in line with a typical market-cap-weighted ETF such as iShares U.S. Credit Bond ETF (CRED) (expense ratio 0.15%). The corporate bond Morningstar Category average is 0.85%.
A Compact Portfolio Run by a Veteran Value Skipper
Harbor Large Cap Value (HILVX) is subadvised by Aristotle Capital Management, a value-oriented investment boutique headquartered in Los Angeles, Calif. Aristotle was founded in 2010 by Howard Gleicher, formerly co-founder, CEO, and CIO at Metropolitan West Capital, a subsidiary of Wells Fargo. Aristotle manages $12.9 billion in assets under management, including $11.3 billion in this strategy.
Although Aristotle was appointed to subadvise this fund in 2012, Gleicher's experience with this strategy dates back to his days at Metropolitan West. He's successfully executed this strategy through a separate account--Aristotle Value Equity--since 2001. Supported by roughly a dozen analysts, Gleicher employs a fundamental, bottom-up approach focusing on companies with market caps above $2 billion. The approach is straightforward: The team targets high-quality companies--characterized by sustainable competitive advantages, attractive business fundamentals, and experienced management teams--with compelling valuations and potential catalysts. Valuation is an important component to the process, but the team prefers quality firms when they're out of favor over mediocre firms trading at fire-sale prices. As a result, this fund lands in the large-blend category. Once management buys, it tends to hold on for the long term, so portfolio turnover should be below average.
While the portfolio is concentrated--typically holding between 35 and 45 stocks--there are some guardrails in place to address risk. The fund's sector weightings must remain within 50%-200% of the S&P 500's, and individual position sizes are capped at 6% of assets. Moreover, the fund can invest in non-U.S. securities, but exposure must remain below 20%. The approach has worked thus far: The fund has posted solid absolute and risk-adjusted performance versus both the Russell 1000 and Russell 1000 Value indexes since Aristotle began subadvising here in 2012.
A Low-Cost ESG Strategy
IShares MSCI USA ESG Optimized ETF (ESGU) offers market-cap-weighted exposure to large- and mid-cap U.S. stocks that score well on environmental, social, and governance (or ESG) metrics. There is little evidence that ESG filters significantly affect performance one way or another, but this socially conscious fund offers a growth-oriented, broadly diversified portfolio with many of the same advantages as a traditional index fund. The fund's low expense ratio of 0.15% should give it an enduring edge over its peers in the large-blend equity category.
This fund seeks to replicate the MSCI USA ESG Focus Index, which starts with stocks from the MSCI USA Index and targets companies with high ESG ratings. It then employs an optimizer to limit its tracking error versus the MSCI USA Index. This fund excludes the stocks of firms involved in the production of tobacco or controversial weapons and/or those tangled up in severe business controversies. The fund's benchmark index uses MSCI's ESG research and ratings to tilt its holdings toward those names with the highest ESG scores. The optimization process seeks to limit tracking error versus the MSCI USA Index to 0.5% per year and keeps individual security and sector weightings in line with those of the MSCI USA Index. This process eliminates some well-known stocks such as Wells Fargo (WFC), Chevron (CVX), and Philip Morris International (PM), but these constraints should limit the sort of persistent sector bets that drive the returns of most ESG funds.
A Promising Emerging-Markets Vehicle
Neuberger Berman Emerging Markets Equity (NEMAX) has a mix of bolder and more-cautious traits compared with its typical peer and its MSCI Emerging Markets Index benchmark. Conrad Saldanha, who has run the fund since its October 2008 inception, seeks companies that have relatively solid balance sheets yet are still able to generate above-average returns on equity. Given that tilt toward sturdier fare, it's rather counterintuitive that the fund owns a bigger stake in small- and mid-cap stocks than the category norm and the index. Thus far, the results have been impressive; the fund has edged the benchmark and beaten the majority of its peers on total return, while its risk-adjusted returns (as measured by Sharpe ratio) are topnotch. That said, it remains to be seen how the fund will fare in an extended downturn. Fees are slightly above-average here, but the fund's asset base is fairly modest in size. Saldanha is backed by an experienced team of four as well as a larger global equity team.
A Proven Long-Short Process
Prudential QMA Long-Short Equity (PLHAX) is managed by a wholly owned subsidiary of Prudential that manages more than $100 billion across a broad multi-asset lineup. The funds share the same core quantitative process, managed by a deep bench of 56 well-credentialed managers and analysts. Although this fund's track record is relatively short, its quant model has been used to short stocks since 2004. This includes a 130/30 separate account strategy (approximately 130% long positions combined with an approximate 30% short sleeve) that's turned in solid results since its 2006 start date.
This fund's model picks stocks from the Russell 3000 Index. The broad selection pool means this fund can own a higher percentage of small-cap stocks than its typical long-short equity category peer (in both the long and short sleeves). But a diversified portfolio of about 230 long positions and an equal number of short positions helps prevent a single holding from having disproportionate influence. Although pricing inefficiencies within small caps offer upside opportunity, short positions in small caps can increase the fund's volatility. As a result, the managers keep mid- and small-cap exposure net neutral.
The process sorts stocks into three categories based on earnings growth expectations: slow, average, or fast. The model scores each stock using inputs that broadly roll up to three factors--value, growth, and quality--and the factor weightings adjust based on the growth category grouping. The managers have been adjusting this model since 1996 and regularly test for new factors, but changes are infrequent. Model-driven results and portfolio manager input combine to construct the overall portfolio's sector weightings and net exposure. As a result, sector weightings and net exposure have varied since inception. On average, investors should expect net exposure to be close to 50%, which is close to the category norm.
Greg Carlson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.