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Morningstar FundInvestor
October 2016
Our analysts regularly review Morningstar Analyst
Ratings, and sometimes even old favorites end
up being downgraded. Ratings changes can serve
as a signal to shareholders that it may be time to
review the holding.
Risk Concerns
September saw an unusually dramatic fall from favor
when
Fairholme
FAIRX
dropped to Neutral from
Silver. Such drops are often precipitated by manager
changes, but in this case longtime manager Bruce
Berkowitz remains at the helm, employing the charac-
teristically bold, idiosyncratic strategy that made
his name. Turnover on the team supporting Berkowitz
is troublesome, but liquidity concerns drove the down-
grade. While the fund still has a sizable cash stake,
it has also suffered net outflows every month for more
than five years, and the portfolio is highly concen-
trated in less liquid positions such as
St. Joe
JOE
.
We downgraded
Fairholme Focused Income
FOCIX
late last year after
Third Avenue Focused Credit
was forced to suspend redemptions, reasoning that
Focused Income’s strategy was also ill-suited for
an open-end vehicle that must meet daily redemp-
tions. That argument can be applied to the Fairholme
stock strategy as well: Even shareholders who remain
confident in Berkowitz and his picks may be at the
mercy of those who leave and force untimely trades.
Risk is also the story behind the May downgrade of
Morgan Stanley Institutional Growth
MSEGX
,
one of the most volatile funds in the large-growth
Morningstar Category, which can make it difficult
for shareholders to stay the course. However, it still
remains an excellent option in the category for
those with the requisite risk tolerance, as its new
Analyst Rating of Silver indicates. On the other
hand,
Fidelity Capital Appreciation
FDCAX
moved
to Neutral from Bronze in April; manager Fergus
Shiel’s vague process involves big bets on industries
and companies that have invited excessive risk
without sufficient compensation.
Less Compelling
Weitz Hickory
WEHIX
and
Weitz Partners Value
WPVLX
were downgraded to Bronze from Silver
in August, as was
Weitz Value
WVALX
in May. These
funds have shied away from their contrarian past,
taking more of a quality-oriented bent as the managers
have loosened the valuation requirements in their
process. It’s hard to argue with the prudence of buying
quality, but quality is a crowded trade these days,
and while this change could result in lower volatility, it
does present additional valuation risk. The funds are
now less differentiated from peers, and above-average
expenses remain a hurdle.
Franklin Federal Tax-Free Income
FKTIX
and
Franklin
High Yield Tax-Free Income
FRHIX
are managed
by experienced teams and feature low price tags. The
buy-hold processes used are sensible and straightfor-
ward but haven’t generated a significant advantage
relative to rivals in the funds’ respective categories in
the past several years. Both funds were downgraded
to Bronze from Silver this summer.
We took a fresh look at
Natixis ASG Global Alterna-
tives
GAFAX
and concluded that poor performance
highlighted inherent problems with its process, lead-
ing to a downgrade to Neutral from Bronze. The
fund uses a quantitative process to replicate the liquid
broad market exposures of the hedge fund industry,
but it is limited by its reliance on a narrow universe of
liquid tradable markets and on monthly data from
fragmented hedge fund indexes.
Manager Changes
Funds can thrive after the departure of even a great
manager.
MFS Global Equity
’s
MWEFX
management
team won’t be as strong after the upcoming retire-
ment of longtime manager David Mannheim, so we
lowered its rating to Silver from Gold in July. The fund
remains a terrific source of exposure to the world’s
blue chips, however. The strategy will stay intact, and
Roger Morley, who became a comanager on the
fund in
2009
, remains in place.
K
Watch Out for Downgrades
Red Flags
|
Laura Lallos
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.