More often than not, the Morningstar Rating for funds, or "star" rating, and the Morningstar Analyst Rating are in general agreement. But there are times when there’s a sharp contrast between the two.
The star rating is a purely quantitative, backward-looking measure that rates funds based on their risk-adjusted returns over three-, five-, and 10-year periods. Funds are rated versus their Morningstar Category peers and then given star ratings, with equal numbers above and below 3 stars. The star rating is updated monthly.
The Analyst Rating is a fundamental, forward-driven rating in which we evaluate a fund’s long-term prospects for superior risk-adjusted performance relative to peers and benchmark. We rate based on price, people, process, parent, and performance. We know that price is a better predictor than past performance, so the Analyst Rating naturally places less weight on past performance than does the star rating. The Analyst Rating is updated whenever there’s a material change in fundamentals but at least every 12 months.
Where the two rating systems diverge is generally attributable to a difference in forward-looking fundamentals versus past performance. Sometimes it’s even down to a different view of past performance, as we like to look at a manager’s entire track record and that can be much longer or shorter than 10 years. To illustrate the key differences, I’ve selected a few Neutral-rated funds that had 5-star ratings as of the end of April. Please read our whole analysis of each fund to get the complete story.
Fidelity Small Cap Value (FCPVX) has great past returns and decent fees. However, most of that great track record belongs to Chuck Myers and Derek Janssen. Myers was the lead up until January 2015 when Janssen was elevated to lead from comanager so that Myers could focus on Fidelity Small Cap Discovery (FSCRX). That transition spurred us to downgrade to Bronze from Silver as Janssen was relatively inexperienced. However, Myers announced plans to retire in 2017, setting in motion another change, as Janssen was tapped to run that fund and Clint Lawrence was named to take over this one. Lawrence brings to the table 10 years of experience as a small-cap analyst but not much as a portfolio manager. Thus, we lowered the rating to Neutral.
Lord Abbett Short Duration Income (LALDX) is a 5-star $40 billion fund, so clearly we are not in agreement with the investing public, which is all over this fund in part because it boasts a nice yield for a short-term bond fund. But that is part of our concern. Yields are rising finally in short-term bonds, but, until recently, a sizable yield required sizable risks, and most investors don’t want that from a short-term fund. The fund dialed up investments in higher-risk sectors such as commercial mortgage-backed securities, asset-backed securities, high-yield corporates, and investment-grade corporates. We’re wary of the credit risk it has taken on, and we worry that it might lose more than its peers in a credit sell-off.
Stadion Tactical Growth (ETFAX) has put up nice returns in the tactical allocation group. But it costs 1.77% for the A shares, and that’s a tough hurdle to overcome. I’ve found that low-cost funds with poor past returns outperform high-cost funds with strong past returns. The strategy here is to quickly trade among exchange-traded funds that have the highest Sharpe ratios. It’s similar to a momentum strategy in which management keeps moving to the hottest hand. In a way, Stadion does that with its own funds. It has launched a number of funds over the years and then liquidated those with poor performance. Thus, you should take this fund’s strong results with a grain of salt. We give the Parent and Price a Negative rating.
Oppenheimer Global Opportunities (OPGIX) has been a winning investment for shareholders under manager Frank Jennings. Unfortunately, the future is less clear. The fund is a classic example of key-man risk. Jennings is 70 years old and backed by just one analyst who was hired in 2017. Thus, it’s not clear who will be running the fund in a few years, nor what strategy he or she will employ at this $9 billion fund.
Delaware Smid Cap Growth's(DFCIX) manager Alexander Ely is coming up on his two-year anniversary at the fund. He took something of a pratfall out of the gate in 2016 as the fund lost 4.33% only to come roaring back with a 35% gain in 2017. We don’t know if Ely is skilled, but we do know his concentrated theme-driven strategy is quite volatile.
Goldman Sachs High Yield Muni’s (GHYIX) aggression is apparent when you look at the calendar-year returns. The fund endured losses of 29.9% in 2008 and 5.5% in 2013 but also produced nifty gains of 29% in 2009 and 16.3% in 2012. The fund had 37% in bonds rated B or lower or unrated and that is 8 percentage points more than peers. It generally takes a recession in order to find out who has managed credit risk well and who hasn’t.
Russel Kinnel does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.