Christine Benz: Hi, I'm Christine Benz for Morningstar. Among thousands of mutual funds, how can investors go about identifying the ones that are worthwhile? Joining me to share four income-friendly funds is Russ Kinnel. He's Morningstar's manager research director. Russ, thank you so much for being here.
Russ Kinnel: Glad to be here.
Benz: Russ, every year you take a look at the Fantastic 40. It moves around a little bit, but you run a screen where you take the broad fund universe and you look at funds on a number of different variables, and you actually get it down to a fairly short, manageable list. This year it's how many, 36 funds?
Kinnel: It's 36 funds, yes.
Benz: You've got 36 funds. Let's talk about the screens that you put in and use to arrive at this shorter, more manageable list.
Kinnel: Sure. Well, the idea is that there's 8,000 funds out there, but really only a few data points that are particularly vital in selecting the best funds. So instead of having a lot of screens, what the idea is, just to have a few screens but really be stringent with each one of them, and a small number of funds comes out. Sometimes it's in the 30s, sometimes it's in the 40s, but it's just six core screens is all that I'm doing to get to that list.
Benz: Expenses, I know, are top of mind. What other things do you look at?
Kinnel: That's right, so cheapest quintile expense ratio, manager investment over $1 million, Parent rating of Above Average or High, medalist rating, so Bronze or better, and Morningstar Risk cannot be high. The idea is that high Morningstar Risk, people tend to have a harder time making good use of higher-risk, more-volatile funds, so we'll screen out just the high-risk funds.
Benz: In general, the idea with all of the criteria that you put in there, you're looking for better investor outcomes. You're looking for things that we have found are correlated with better performance.
Kinnel: Exactly. Manager investment is correlated with better performance. Low fees are correlated with better performance. Our Analyst Rating, we think, is correlated with better performance. Still, to a degree, you could say that the jury is still out on that one, but yeah, that's the basic idea.
Benz: You brought a short list of funds that cleared all of the hurdles for 2020. The funds that we're going to talk about today all do have some sort of an income focus, which I think is an interesting thrust to discuss, especially given how low yields are today. So the idea is that you brought a group of funds that you think have a sane approach to delivering investors income. Let's start with a fund that has been a longtime favorite among our Morningstar.com readers and viewers. That's Vanguard Wellesley Income. It looks good and made it through your screens.
Kinnel: Oh yeah. Of course, it ticks all the right boxes. Vanguard, a great parent, super low fees, great track record. It's a fund that's to have beaten its benchmark over the manager's tenure, so really just does a great job on so many fronts. The idea is that they have 65% fixed income, 35% in equities, and the equities are also expected to generate a dividend. It's led by Michael Reckmeyer of Wellington, and obviously just a really great steady-Eddie fund. You just look at that year-on-year, consistently pretty good returns, pretty good yield, and of course, when you have fees as low as you get from a Vanguard fund, you don't have to stretch for yield. A manager with a fund that's charging 1% or 1.5% is going to have to take on a lot of risk just to get even with this fund, which is so cheap.
Benz: Next fund on your list that cleared the screens is American Funds American Mutual. Let's talk about that one.
Kinnel: We mentioned Wellington, who's good at investing in dividend stocks. Capital Group American Funds, this is also in their wheelhouse. They're just very good at finding good companies that pay a good yield. So they want--the target for this fund is to have a yield above the S&P 500, but they don't want to do so with a lot of risks. So they look for healthy companies as well. You can see that versus some other equity-income funds, this one doesn't have a huge weighting in energy utilities. You can see the consistent performance that, even in a year like this year where a lot of higher-yielding stocks got punished because there was a lot of credit risk there, this fund is just a very smooth sailor. Lost much less than its peer group, so really a strong Gold-rated fund.
Benz: Switching over to fixed-income funds, Fidelity Total Bond made your list. Let's talk about that fund, Russ, and I'd like to hear how it performed during the first quarter, which was such a great stress-test for bond funds.
Kinnel: Oh, sure. So this one's run by Ford O'Neil. It's in our intermediate core-plus fund category, which means these are a little more aggressive than the typical core fund. So what that means is you're going to have more credit risk. In particular, this fund has a 20% budget for high-yield and emerging markets, so it can be aggressive. But it is, like you see at a lot of Fidelity funds, it's very focused on issue selection, on quantitative research. And so the fund lost about in line with peers in the downturn, but is actually doing pretty well for the year to date. So I think pretty respectable. The fund's kind of managed nicely and when it has high-yield weightings and when it doesn't, and that really shown through this year, as well as over the long term.
Benz: And its name notwithstanding, it's not an index fund. It sounds like it could be, but it's not.
Kinnel: That's right. It's actually an active fund with more risk than a total bond stock or total bond market index fund would have.
Benz: And then Dodge & Cox Global Bond is also on your list. We also like Dodge & Cox Income fund, but let's talk about the global bond fund.
Kinnel: Yeah. Our first three funds were kind of old-timers. This one's only been around for six years, and because I require manager tenure of at least five years, it's only recently become eligible, but I really like this fund. Dodge & Cox is really a company researcher, and so you see that reflected in the portfolio. It's about half corporate bonds, which is really unusual for a world bond fund. Most of those funds really love sovereign risk. They're betting on countries. Here, they're betting on individual securities because that's what Dodge & Cox does so well. They've got great analysts who are really good at researching the whole capital structure of a fund, of a company. And you see that in the performance. It's really good. And it's still a small fund. Under $1 billion. But what's great about Dodge and Cox is they charge a low fee from the beginning. So this fund charges 45 basis points. You don't have to wait for it to be massive to get a good value on the expense ratio.
Benz: Russ, if people want to see the whole list, they can look at Morningstar FundInvestor. This is in the August issue of FundInvestor, where you have all funds that cleared the screen. Is that correct?
Kinnel: That's right.
Benz: Russ, thank you so much for being here.
Kinnel: You're welcome.
Benz: Thanks for watching. I'm Christine Benz for Morningstar.com.