(PUB) Investing 2015

February 2 015

Morningstar FundInvestor

11

Hot Performers With High Price Tags Red Flags | David Kathman

PIMCO fired a key analyst, Rahul Seksaria, for executing an improper trade nearly three years earlier.

Tweedy, Browne Global Value TBGVX This fund’s 1 . 37% expense ratio is higher than almost 90% of no-load foreign large-value funds. Despite that headwind, it has compiled a very strong long- term record by using a Warren Buffett-like approach to overseas value investing, emphasizing high-quality stocks with strong franchises. It was barely in positive territory in 2014 with a 1 . 5% gain, but that was one of the best returns in the foreign large-value category in a tough year for foreign stocks. However, this outperformance came almost entirely from the fund’s practice of hedging its foreign-currency expo- sure into the U.S. dollar, which has been strong lately; its 2014 return trailed the MSCI EAFE 100% Hedged Index benchmark by 4 percentage points. That’s not too much reason for worry, given that the fund has trounced the hedged benchmark over the long run, but it might not look as good in the short term if the dollar weakens. Amana Growth AMAGX Price has always been the biggest issue tempering our enthusiasm for this otherwise excellent fund. Although its expense ratio has come down steadily over the past decade, at 1 . 09% it’s still more expensive than two thirds of large-cap no-load funds. Manager Nick Kaiser runs it according to the principles of Islamic law, meaning that, in addition to avoiding alcohol, tobacco, gambling, pornography, or pork stocks, it can’t hold financials or overly lever- aged companies. Despite these restrictions, the fund sports some of the best 10 - and 15 -year returns in the large-growth category, though it has struggled over most of the past five years as low interest rates have boosted capital-dependent firms. The fund bounced back in 2014 with a top-decile 14% gain, driven by big gains in such top holdings as Apple AAPL , Amgen AMGN , and Union Pacific UNP . œ Contact David Kathman at david.kathman @ morningstar.com

At Morningstar, we’ve always paid a lot of attention to fund expenses. Plenty of evidence shows that cheap funds outperform expensive ones over time, and that expenses are one of the best predictors of future fund performance in general. That’s why Price is one of the five Pillars that go into the Morningstar Analyst Rating for funds. It’s easy to overlook a fund’s price tag when it’s performing well, but that’s short-sighted, because every fund will cool down eventually. Here are three funds from the Morningstar 500 that had great years in 2014 , ranking in the top decile of their Morningstar Categories, but which also have Morn- ingstar Fee Level ratings of High or Above Average, meaning they’re more expensive than their typical peer. That doesn’t mean they’re bad funds—in fact, two of them have Analyst Ratings of Silver. But these funds’ high price tags are a headwind to future performance, one that’s likely to become more signifi- cant when market conditions aren’t as favorable. PIMCO Global Multi-Asset PGMDX All of this fund’s share classes are more expensive than their peers’. More than half of the fund’s $1 billion in assets are in the Institutional shares, whose 0 . 49% expense ratio is pricier than two thirds of similar world-allocation share classes, and most of the other share classes are in the most-expensive quintile of their peer group. The fund gained 7% in 2014 to rank in the world-allocation category’s top 5% , an impressive rebound from 2013 , when it lost 9% and ranked near the bottom of the category. Most of this great performance came under lead manager Mihir Worah, who took over in early 2014 following the departure of Mohamed El-Erian. But Worah took on further responsibilities in September when he was named co- CIO and comanager of PIMCO Total Return PTTRX following the departure of Bill Gross, and the fund was rocked in December 2014 when

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 departure 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 holdings. But investors should be prepared for a potentially bumpier ride in the near future.