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5 Up-and-Coming or Under-the-Radar Strategies

New Morningstar Prospects include a cautious large-cap stock strategy, a frontier-markets portfolio, and a bank-loan fund.

A version of this article was originally published in the June 2018 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 is published on a biannual basis.

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 five new strategies in the first half of 2018. We highlight them below.

A Risk-Conscious Equity Strategy
AQR Large Cap Defensive Style (AUEIX) is a rules-based, actively managed strategy designed to offer better downside protection and lower volatility than the U.S. equity market. The managers start with the 1,000 largest U.S. stocks and use an optimizer to create a constrained portfolio with two objectives: lowest expected volatility and highest stock quality. To achieve the first objective, the model considers both individual stock volatility and correlations across the group. Highly volatile stocks can make the cut with low enough correlations to the group.

AQR measures quality with profitability, earnings volatility, leverage, and default risk, giving greater weight to a stock's performance against industry peers than the entire selection universe, improving comparability. To improve diversification, the fund constrains its sector weightings to an equal risk-weighted version of the starting universe, allowing for defensive sector tilts. The managers update the portfolio quarterly, but they can avoid trading when the expected costs exceed the benefits. This approach has worked well, giving the fund one of the most favorable upside-/downside-capture ratios in the large-blend Morningstar Category from its inception in July 2012 through June 2018. During that time, it outpaced the Russell 1000 Index by 35 basis points annualized with slightly lower volatility and much better performance during market downturns.

A Wide-Ranging Approach From a Proven Team
Artisan Global Discovery (APFDX) is just shy of its first birthday, but it comes with an impressive pedigree. Its four portfolio managers are part of a team that has steered  Artisan Mid Cap (ARTMX),  Artisan Global Opportunities (ARTRX), and  Artisan Small Cap (ARTSX) since 1997, 2008, and 2009, respectively, and all three funds earn Silver ratings. The team's history of investing abroad in a substantial way is a bit shorter--world large-stock fund Artisan Global Opportunities moved from the large-growth category (which focuses heavily on U.S. stocks) in 2012. But the team was careful to add analysts with expertise in non-U.S. firms before gradually ramping up that fund's stake in such stocks over a period of several years.

Most of this fund's holdings are also owned by one or more of the team's other charges. That's comforting, as it suggests the team isn't straying too far into unfamiliar territory. But capacity bears watching, as Artisan Mid Cap and Artisan Small Cap are closed to new investors and Artisan Global Opportunities is nearing the team's capacity estimate. Artisan Mid Cap is seeing substantial outflows, however, and the team doesn't intend to reopen it soon as it creates room for this fund (which owns a hefty stake in mid-caps) to grow. If this fund does increase in size, its currently high fees should decline.

Moving Up Into Mid-Caps
Conestoga SMid Cap's (CCSGX) lead manager Bob Mitchell, who also helms Silver-rated  Conestoga Small Cap (CCASX), extends his firm's small-cap approach here into mid-caps. Alongside comanager Derek Johnston and three other members of Conestoga's investment committee, Mitchell seeks companies with sustainable 12%-15% earnings-growth potential for at least three years. The team also likes high equity returns, low debt, and meaningful management ownership. Mitchell and Johnston build a portfolio of 40-60 holdings, sharing roughly half with the small-cap portfolio as of April 2018. Having tracked many of these companies for years, the managers can take a long-term view and trade patiently. The team also works within reasonable parameters--such as capping the small-cap overlap at 35 names and trimming when a stock reaches $15 billion in market capitalization--that give the process discipline and structure. Mitchell's success has led Conestoga to restrict access to the small-cap fund, but this small- and mid-cap offering (which launched in early 2014) still has plenty of capacity. Hefty expense waivers also keep costs down for investors. These attractive features make up for the fund's short track record.

Bringing a Wealth of Resources to Floating-Rate Bonds
Paul Massaro joined T. Rowe Price Institutional Floating Rate (RPIFX) as a co-portfolio manager in May 2009 and has led the effort as its sole manager since January 2013. He is supported by a team of 14 credit analysts and leads the floating-rate effort for T. Rowe Price's overall high-yield group, which also manages Gold-rated  T. Rowe Price High Yield  (PRHIX). Massaro and team take a fundamental approach here. They focus on bottom-up security selection and have the flexibility to allocate up to 20% of the portfolio to high-yield bonds. Above-average high-yield exposure may result in a more volatile ride for this fund than its typical floating-rate peer, though Massaro has generally kept its allocation in line with the group at 10% or less of assets. The fund has also held a few percentage points more than peers in lower-quality debt rated CCC and below when Massaro has found compelling opportunities, but the fund has shown resilience during periods of market stress on his watch. For example, the fund lost less than 80% of its bank-loan peers during the high-yield and energy market downturn from mid-2014 through early 2016.

Overall, the fund has fared well during Massaro's tenure as lead manager, outpacing 85% of its bank-loan peers on a risk-adjusted basis (as measured by Sharpe ratio) from January 2013 through June 2018. Its fees also rank in the cheapest decile of similarly distributed bank-loan category peers, which further sweetens the pot.

Ably Navigating Dicey Markets
Oliver Bell joined T. Rowe Price in 2011 and has managed T. Rowe Price Institutional Frontier Markets Equity since its inception in September 2014. Before joining T. Rowe Price, he spent 14 years managing emerging- and frontier-markets portfolios at Pictet Asset Management. At T. Rowe Price, Bell is supported by a team of five dedicated analysts, one of the largest teams focused purely on frontier markets. The equity and fixed-income analysts in the broader emerging-markets group also support Bell and his team. The bond team is particularly helpful for analyzing geopolitical risks. The strategy is nonetheless bottom-up-driven, with a strong emphasis on the quality of management and corporate governance. This fund is differentiated by its focus on frontier markets compared with most of its competitors in the diversified emerging-markets category. While still relatively short, the fund's track record is encouraging; it outpaced the MSCI Frontier Markets Index from Bell's September 2014 start through June 2018 without taking excessive risk. Frontier markets haven't performed as well as emerging markets over this period, so the fund trails the broad category.

Greg Carlson does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.