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Morningstar FundInvestor
January 2
014
This year marked the fifth anniversary of the
2008
financial crisis and market meltdown. It’s nice to see
that terrible time retreating further into the rear-
view mirror, but this anniversary also means that the
brutal losses of
2008
have been rolling off mutual
funds’ five-year returns, replaced by gains from the
past year’s bull market. That makes those losses
less visible, which is good news for funds that got
hammered in
2008
, but bad news for investors
trying to evaluate funds and their long-term records.
Quite a few funds took it on the chin in
2008
,
landing in their categories’ bottom deciles, but have
rebounded strongly to achieve top-decile five-year
returns as of December. You should be most wary of
those with a Negative or Neutral Morningstar
Analyst Rating.
Nuveen High Yield Municipal Bond
NHMAX
High-yield bond funds, including high-yield municipal-
bond funds like this one, got hit especially hard by the
credit crisis in
2008
. This fund’s aggressive strategy
focuses on bonds with long durations and plenty of
credit risk, features that boosted returns during the
good times but took a major toll during the crisis. Big
losses in these credit-sensitive holdings, made worse
by leverage, caused shareholders to pull money out of
the fund and forced manager John Miller to sell hold-
ings, resulting in a devastating
40%
loss in
2008
. The
fund has since bounced back strongly with some of
the high-yield muni category’s best five-year returns,
but the risks from its aggressive approach have not
gone away, resulting in an Analyst Rating of Neutral.
Putnam Diversified Income
PDINX
This multisector bond fund has historically allocated
its portfolio among high-yield bonds, mortgage-
backed securities, and non-U.S. bonds, and it gener-
ally has avoided interest-rate risk in favor of credit
risk and liquidity risk. This proved a toxic combination
in
2008
, when liquidity dried up and mortgages got
hammered as the housing market imploded. As with
the Nuveen fund, leverage magnified the fund’s
problems, leading to a
36%
loss that was among the
worst in the multisector bond category. The fund
rebounded with a
58%
gain in
2009
but again ranked
near the bottom of the category in
2011
, highlighting
the considerable risks. Despite its top-decile five-year
returns, the fund has an Analyst Rating of Negative.
John Hancock Classic Value
PZFVX
As its name implies, this fund employs a classic value
strategy, trying to identify large-cap stocks that
are historically cheap but have good prospects for
recovery.Manager Richard Pzena and his team run
a fairly concentrated portfolio in which sector weight-
ings can differ quite a bit from the broader market.
That strategy backfired in
2008
when the fund lost
nearly half its value because of a big bet on financial
stocks, including Lehman Brothers, Washington
Mutual, Fannie Mae, and Freddie Mac. The fund re-
bounded nicely from that debacle and has had
a great year in
2013
, but the risks of its contrarian
strategy contribute to a Neutral Analyst Rating.
Legg Mason Opportunity
LMOPX
Bill Miller has had his ups and downs, but man are
the downs dangerous. Miller made a big bet on finan-
cials in
2008
, contributing to a gut-wrenching
65%
loss that was followed by an
83%
gain in
2009
when
the market’s riskiest stocks rebounded. Since then,
the fund has ranked at either the bottom or the top of
the mid-cap value category each year. While its five-
year returns currently look great, the fund’s long-term
returns haven’t compensated for the huge swings,
resulting in an Analyst Rating of Neutral.
œ
Contact David Kathman at
Don’t Be Fooled by These Funds’
Five-Year Returns
Red Flags
|
David Kathman
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.
