(PUB) Morningstar FundInvestor

May 2 014

Morningstar FundInvestor

11

Good Funds With Big Credit Risks Red Flags | Shannon Zimmerman

2008 – 09 lows—an annualized gain of 17 . 3% ranks in the top quartile.

Huggins left the team in 2012 , a year in which Weil- heimer (in place here since January 1996 ) turned relatively cautious and, perhaps not coincidentally, the fund turned in its first subpar year since 2008 . And while it placed in the category’s top quartile in 2011 , the fund shed 5 . 7% during that year’s third quarter, the toughest “stress test” high-yield has faced since March 2009 . Fidelity Capital & Income FAGIX Managed since 2003 by Mark Notkin, this Silver-rated high-yield bond fund is super aggressive. Versus a category norm of less than 2% , its current equity stake hovers near 19% . And while its allocation to CCC rated bonds isn’t especially high right now, Notkin has been willing to invest significantly in them in the past. The fund’s returns have been nearly as predictable as its volatility. Like Eaton Vance Income Fund of Boston, it placed in the category’s bottom quintile in 2008 with a loss of 31 . 9% . It shed 10 . 8% in 2011 ’s third quarter, too. During 2009 ’s junk rally, though, the fund sailed past not only the Eaton Vance fund but also virtually all category rivals, securing a spot in the peer group’s top percentile with a gain of 72% . Eaton Vance Floating Rate EVBLX This Gold-rated fund strikes a milder profile than most of its bank-loan category peers. It still slipped into the category’s bottom half in 2008 , though, suffering a loss of 30 . 4% . And while it outperformed most peers in 2011 ’s third quarter, the fund shed 3 . 1% of its value nonetheless. More worrisome is the pace of inflows for the broad bank-loan category; amid investors’ mad scramble for yield, assets rose to $ 145 billion from $ 87 . 8 billion in the trailing 12 months through March 2014 . When the market corrects, this fund will probably fare better than most. It likely won’t escape unscathed, though. œ Contact Shannon at shannon.zimmerman@morningstar.com

No fund strategy can succeed in every market envi- ronment, but investors who know what to expect can put inevitable slumps to good use by adding to (or at least just sticking with) their underachievers. Recent history underscores the virtues of patience: The funds that soared highest during 2009 ’s risk rally, after all, typically ranked among their catego- ries’ laggards during 2008 ’s stampede into quality. The Medalists below placed in the bottom half of either the high-yield bond or bank-loan categories in 2008 but fared much better in 2009 . Particularly in the case of the two high-yield funds, that perform- ance was largely predictable. Plenty of credit risk comes baked into their category, but those funds haven’t just courted that risk, they’ve embraced it: Historically, their managers have been more willing than most to step down the credit-quality ladder. It was no surprise, then, that when capital markets froze during 2008 ’s credit crunch, these funds suffered more than most. More than five years into a rally that’s been especially favorable for riskier fare, investors shouldn’t just be prepared for a pull- back, they should be prepared to make the most of it. Eaton Vance Income Fund of Boston EVIBX This Silver-rated high-yield-bond fund’s 30 . 3% loss in 2008 landed in the category’s bottom quintile, dragged down by an overweight slug of B rated bonds. Amid tough economic times, generous exposure to hard-hit leisure-industry debt also dinged results. Comanagers Mike Weilheimer and Tom Huggins stuck to their guns throughout that period, and inves- tors who stuck with them were compensated for their patience. In 2009 , a 57% gain placed just outside the peer group’s top decile. In the trailing five-year period through March 2014 —a stretch that captures the high-yield market’s dramatic recovery off

What is Red Flags? Red Flags is designed to alert you to funds’ hidden risks. Such risks can take many forms, including asset bloat, the depar- ture of a solid manager, or a focus on an overhyped asset class. Not every fund featured in Red Flags is a sell, and in fact, some are good long-term hold- ings. But investors should be prepared for a potentially bum- pier ride in the near future.