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Fund Spy

Behind the Scenes with Our Fund Analyst Picks

Find out why one category has 12 selections and other groups have none.

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Our  Analysts Picks list narrows down the thousands of available funds into the top choices in each category. For a refresher on how we make those decisions, check out this article. But put simply, these funds are our favorites. Although there are many, many acceptable funds and a good number of slightly better choices that can make for fine holdings, only an elite few rank as the cream of the crop.

Closed Funds Can Make the Cut
Right off the bat, it's important to highlight one change that we made in 2005. Before that, we had excluded funds that were closed to new investors. It seemed better to make the Analyst Picks list a collection of funds that readers could use when trying to assemble a portfolio or adding a new fund to an existing collection. Naming funds that people couldn't get into didn't seem appropriate.

Over time, though, we received many comments from readers who disagreed. After all, most closed funds already have a large number of shareholders, and those investors have a critical interest in knowing whether their funds still qualify as Analyst Picks or have fallen off the list for some important reason. What's more, many closed funds allow advisors who already have clients in the fund to continue putting new clients into it. Under these circumstances, we decided that if a fund satisfied our other stringent standards for the list, it could become an Analyst Pick even if it was closed or even remain on the list if it closed its doors after it was chosen.

The Best--In the Category
We choose Analyst Picks in most categories. In other words, we don't just lump all mutual funds together and pick our favorite few. That's because most people these days are looking for a specific type of fund. So we go category-by-category, identifying the best domestic large-value stock funds, the best domestic large-blend stock funds, and so on for every category.

As a result, even a specialized or risky category is evaluated for Analyst Picks and probably has at least one named. We figure that the decision whether to buy a small-growth fund or a precious-metals fund is yours. Once you've decided that you're interested and are looking to Morningstar to help you find one, it's our responsibility to steer you toward the top few and away from the worst.

As a result, it's important to note that we don't think every Analyst Pick is equally important or valuable. Many of the picks from sector categories, or regional foreign categories, can be dismissed if you're simply trying to build an initial diversified portfolio. We're certainly not saying you should give equal consideration--or weightings--to  T. Rowe Price Latin America (PRLAX) as to domestic large-blend stalwarts  Selected American Shares (SLASX) or  Longleaf Partners (LLPFX) or stellar core-bond choice  Dodge & Cox Income (DODIX).

How Many Make the List?
So, if we're going category-by-category, then we list the same amount of picks in each category, right? Well, no. Some categories contain very few funds in total; it's unlikely that such a category would boast more than one or two superior funds worthy of admission to our highest circle. By contrast, with so many funds in the bigger, more popular categories, there's simply a better chance that at least five or so will merit selection. It's not just a matter of the large number of funds available, either. Fund firms want their top managers on funds in the most popular categories. Also, strong managers who are running their own shops tend to give themselves lots of leeway rather than choosing narrow mandates for themselves. As a result of all these factors, a relatively large percentage of outstanding stock- and bond-pickers captain funds in the broad core categories.

These factors help explain why the domestic large-blend category has 12 Analyst Picks, domestic large-value seven, and intermediate-term bond eight. Conversely, it helps explain why the Latin America and high-yield municipal-bond categories each contain just one pick.

Another reason that some of the broader categories have more picks is that they contain different styles of funds within the same group. Don't get us wrong; we don't make an effort to represent every type of approach in a category with a distinct pick. But we do, in some categories, make a point of selecting the best index-tracking funds along with the best actively managed ones if all are outstanding examples of their type. We don't want to make the choice between indexing and active for you; we think both types of funds can be worthwhile. Similarly, we might list the best tax-managed fund in a category for those investors owning funds in accounts exposed to the full weight of taxation, but we also recognize that a great many folks have tax-sheltered accounts, so we include less-tax-efficient Analyst Picks as well.

Making Sector Calls?
It's worth noting that our limited number of picks in the Latin America and high-yield muni-bond groups, or our lack of any picks in the natural-resources and Japan categories, should not be taken as indications that we are predicting downturns in those sectors. We don't intend the Analyst Picks lists to provide forecasts about expected performance in specific sectors or regions or for the markets as a whole. The only reason that a few categories have no picks is that, while they may have a couple of solid choices, there are none that truly reach the highest level in our estimation.

That said, there's no doubt that our decisions are influenced, at least slightly, by our judgment about how many investors really should be concentrating on adding a fund from an area. For example, we've pointed out in other columns that most broad international funds have meaningful exposure to Japanese stocks. So, we think that an ordinary investor is better off focusing on making sure that the rest of his portfolio contains broad diversified funds that meet his overall goals rather than trying to fine-tune his Japan exposure by adding a fund dedicated solely to that realm. If we decide that a Japan fund or natural-resources offering does merit Analyst Pick status, we'll definitely award it. But it's safe to say that we're not as concerned about having no picks in those categories as we would be if the domestic large-blend category had no picks.

Not a Buy or Sell Signal
Finally, remember that the fact that a pick appears on the list does not mean it's automatically appropriate for you personally. And if a pick you own is dropped from the list, that doesn't automatically mean that you should sell. It might only mean that we've changed our opinion to very good from best-of-the-bunch. If you have a large amount of taxable gains, it would make sense to stick with the fund; it will probably continue serving you quite well. On the other hand, if a fund loses its Analyst Pick status because of a drastic and worrisome change of management or strategy, then selling would be a wise move to consider. Read our analyses of the individual funds to figure out which course applies in each situation.


Gregg Wolper does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.