These Prospects Are Worth a Look
Five prospective strategies that may be under your radar.
This article was originally published in the February 2019 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting the website.
Twice a year, Morningstar's manager research analysts publish Morningstar Prospects, a list of up-and-coming or under-the-radar investment strategies that are not currently covered by the research group but might be in the future. The list provides advance notice of some promising funds you might want to put on your watchlist.
Funds graduate to full coverage when the team is comfortable assigning a Morningstar Analyst Rating. Prospects sometimes drop from the list if there are negative fundamental changes, such as investment team turnover or a material change to the investment process, or if investor interest isn't strong enough to maintain coverage.
Several analyst-rated funds debuted on Prospects. Silver-rated Alger Small Cap Focus AOFAX joined the list since Morningstar analysts knew manager Amy Zhang from her days at Gold-rated Brown Capital Management Small Company BCSIX. Others, such as Mairs & Power Small Cap MSCFX and Vanguard Tax-Exempt Bond Index VTEAX earned inaugural Silver ratings and haven't looked back.
Here are five intriguing Prospects:
Baird Core Intermediate Municipal Bond's BMNSX management team is tenured. Lead manager Duane McAllister and two comanagers joined Baird in 2015 from BMO, where McAllister led BMO Intermediate Tax-Free Fund BITAX to the top of the muni national intermediate Morningstar Category. The team's prudent risk-management approach makes it a good fit with Baird. Like the firm's taxable team, this group emphasizes bottom-up security analysis and risk management, complemented by fees low enough to discourage excess risk-taking. As of October 2018, it owned mostly bonds rated A or above, while below-investment-grade and nonrated securities stood below 5%. The trio is off to a strong start, topping the Bloomberg Barclays 1-15 Year Municipal Index while landing in the top third of the category through December 2018. Risk-adjusted returns during the same period look even more compelling, with the fund's Sharpe ratio topping roughly 85% of peers.
Baron Discovery BDFFX comanagers Laird Bieger and Randy Gwirtzman are promising up-and-comers. They joined Baron in the early 2000s, supporting Silver-rated Baron Small Cap's BSFIX manager Cliff Greenberg, and launched this small-cap fund in late 2013. Greenberg remains a resource and mentor, but the two have given this fund a distinct profile. Baron Small Cap skews higher on the market-cap spectrum, whereas this fund offers pure small-cap exposure, with an average market cap in line with the Russell 2000 Growth Index. This fund also is more willing to invest in earlier-stage and riskier fare such as biotech and pharmaceutical companies. Thus far, the fund is off to an outstanding start, almost doubling the Russell 2000 Growth Index from its inception through December 2018. But brace for the volatility that comes with such eye-popping returns, as illustrated by the fund's bottom-decile 2015 result. The managers have yet to be tested by a sustained downturn, and above-average expenses are a headwind. However, this $400 million fund is an intriguing, open small-cap option.
Conestoga SMid Cap's CCSMX lead manager Bob Mitchell, who also runs Silver-rated Conestoga Small Cap CCASX, extends his firm's small-cap approach here into the mid-cap space. Mitchell, comanager Derek Johnston, and three other investment committee members seek companies with at least three years of sustainable earnings-growth potential, high equity returns, low debt, and meaningful management ownership. Mitchell and Johnston build a portfolio of 40-60 holdings, about half of which were also in the small-cap portfolio as of October 2018. Having tracked many of these companies for years, the managers can take a long-term view and trade patiently. The team works within many reasonable parameters--such as capping the small-cap overlap at 35 names and trimming when stocks reach $15 billion in market cap--that give the process discipline and structure. Mitchell's success has led Conestoga to restrict access to the small-cap fund, but this smid-cap offering (launched in early 2014) still has plenty of capacity, and expense waivers also keep costs down for investors.
JPMorgan SmartSpending 2050 JTQBX is designed to help retired investors draw down their portfolio. Anne Lester and her multi-asset team, who also run Bronze-rated JPMorgan Income Builder JNBAX, take a distinctive approach to investing in retirement. This fund is designed for the investor to spend down (or sell off portions of her investment) annually to fund discretionary retirement spending. JPMorgan hopes to achieve its goal by setting an annual target volatility and adjusting allocations to various asset classes accordingly. Meant for those born around 1950, the fund matures in 2050. JPMorgan will typically keep this series' allocations to stocks at 40% of the overall portfolio, though the equity allocation can and has changed in response to changes in market volatility.
Vanguard Core Bond VCORX is the actively managed cousin to Silver-rated Vanguard Total Bond Market Index VBTLX and launched in March 2016. Both strategies invest across the U.S. bond market (with a smattering of international debt), but this takes more active sector allocation and yield-curve positions than its Bloomberg Barclays U.S. Aggregate Bond Index benchmark. Its 0.25% expense ratio also is more than its passive peer's 0.05%. In typical Vanguard fashion, the process here is well-defined, risk-conscious, and benchmark-focused. A team of in-house portfolio managers adjusts the fund's positioning based on where it finds relative value opportunities. To date, that group has been relatively conservative in its credit selection, leaving the fund with far less below-investment-grade fare than its typical peer in the intermediate-term bond category. However, the fund holds more corporate debt than Vanguard Total Bond Market Index. That hurt when rates rose and credit risk sold off in the first four months of 2018, but it has still been competitive. From the fund's March 2016 birth through Feb. 28, 2019, it gained 1.6% annualized, matching its passive sibling.