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Flexible Funds for the Current Market

Although major indexes remain elevated, these funds could be good places to put money to work in the present market environment.

Christine Benz: Hi, I am Christine Benz for With the market touching new highs seemingly by the day, investors may be concerned about putting new money to work in what could be a lofty market. Joining me to share some opportunistic fund ideas for a challenging market environment is Shannon Zimmerman. He's associate director of fund analysis for Morningstar. Shannon, thank you so much for being here.

Shannon Zimmerman: Always good to be with you, Christine.

Benz: Shannon, we've seen the Dow and the S&P 500 [at or near] these new highs, retracing the way back to 2007 highs.

Zimmerman: Back to the future.

Benz: Right. So I think a lot of investors are kind of wondering what's next, and if they do have money that they still want to move into stocks, how should they go about doing it and where should they put it. You brought a few ideas of funds that do have some flexibility built into their strategies that may be able to do a good job putting money to work in this environment.

Let's start with one. I know it's a shop that you know well. This is Oakmark International run by David Herro. He is the lead manager there. Let's talk about why you think this fund is potentially well-suited to the current environment.

Zimmerman: Well, David Herro is perhaps the most opportunistic manager at a shop that is opportunistic across-the-board, almost to the point of being contrarian. David Herro, I think, a couple years back, if you look back to what he did, both in the Oakmark International portfolio and then the smaller cap fund that he runs, Oakmark International Small Cap, after the earthquake and tsunami in Japan--a tragic event, of course--but his assessment was, "The fundamentals of my companies are not affected by this. They had very limited exposure to industries that were directly affected by those events." So his assessment was the fundamentals haven't weakened; the valuations are much more attractive. And so consequently, given his contrarian stance, in both of the funds that he runs he increased his exposure; he didn't decrease his exposure. He didn't even stand pat. He increased his exposure to Japanese equities. And so that makes sense given his orientation as a contrarian value investor. If the fundamentals haven't weakened and it's cheaper, then it should be more attractive to you.

But the fund can be volatile, but also there can dry patches. So the thing that Herro has as an advantage is a long time horizon. He can wait for a while for his thesis to pan out. Folks have by and large used his funds quite well, but you have to be patient if you're going to invest with a contrarian like David Herro.


Benz: So when you say that people have used the funds well, you mean that they have timed their purchases and sales at relatively good intervals?

Zimmerman: Yeah, good question. So if you go to and you look at returns, typically you are looking at total returns, what the fund and fund manager have been able to deliver over the standard trailing periods in calendar years. It's important for me as an analyst and I think for investors considering a fund to look not just at total returns, but to look at what we call investor returns, dollar-weighted returns that account for money flows into and out of the fund, to get to exactly what you've said.

How have investors done, particularly with volatile funds in terms of getting in at the wrong time, perhaps, or getting out at the wrong time? You have to first know yourself as an investor and know what your real risk tolerance is. I mean, I think prior to 2008, folks had a sense of what their risk tolerance was and then 2008 occurred, and it turned out that they weren't as quite risk-tolerant as they thought they were. So, you know yourself as an investor, and one way that you can sort of get a beat on whether or not a fund you are considering is right for your portfolio relative to your risk tolerance, is to look not just at total return but investor returns.

Benz: Oakmark has also preemptively shut some funds when they've thought they were getting hot money or whatever. They had a role in that and maybe staving off investors' worst tendencies.

Zimmerman: They've been quite responsible. I mean they're big shop and some of their funds are quite large, not capacity-constraining large, but still quite large. But, yes, their history is one of being very responsible about at least tightening the inflow spigot when the flows get too hot.

Benz: So stepping out a little bit on the opportunistic spectrum, another fund you brought, it's a less familiar name. This is ClearBridge Equity Income. First, Shannon, ClearBridge is that a load shop, so do I need to work with an advisor or pay a sales charge to get into that fund.

Zimmerman: It is a load shop, and so you would pay the load to get into the fund.

Benz: So unless you have it a 401(k) plan or something like that.

Zimmerman: Exactly, exactly.

Benz: So, let's talk about ClearBridge Equity Income, why you like it and why you think it maybe well-suited to the environment that we're in currently.

Zimmerman: Well, so beginning of the beginning, I like it because--this is a team that has run the fund since only since August 2009, not a very long track record. But the lead manager has been managing fund money since Jimmy Carter was in the White House, the last year of Jimmy Carter's administration. Hersh Cohen is his name and certainly, as long as he has run this fund, but maybe as long as he has been running money, he has run in a separately managed account a dividend strategy. The strategy of that separately managed account closely mirrors what they do at Equity Income.

Benz: So a long history, long track record. And how has that track record been?

Zimmerman: It's been quite strong, both at the separately managed account here and then at ClearBridge Appreciation, which is the fund that he ran for many, many years, pretty much to the same strategy. Now, Equity Income does have a dividend, or income mandate, and it targets current yield primarily by investing in household names opportunistically. So, all managers are opportunistic to a certain degree, right. They're trying to buy stocks when they think there is disconnect between what the stock market has priced the company at and what they believe it's worth. They see that as an opportunity.

This is a little bit more than that, though, because in addition to bringing that value stance to bear--and it is a large-value fund--they have some leeway by prospectus to go outside common stock and pursue their income mandate. So, 20% of the portfolio can be invested in any income-producing securities. So, in the past they've invested in convertible bonds, preferred shares, just plain-vanilla bonds, as well, but they have more latitude than the plain-vanilla equity managers do, such as those at Oakmark, at the level of asset class. So, [the fund has] opportunism in terms of pursuing a value strategy, which Oakmark has, but then also opportunism within that 20% sleeve of the portfolio that they have some latitude about what they can invest in.

Benz: One thing we've been noting, we've been seeing kind of a stampede into anything with income attached to it. Is the manager currently having a hard time unearthing good income-oriented ideas at a decent price?

Zimmerman: I think for all managers who have a sleeve of their portfolios allocated to that, it's a tough time right now. You look at yield, and in real terms some of them are negative, on the Treasuries side at least. So, how are you going to put money to work there? [The yields are] essentially [like holding] cash because your purchasing power is being eroded by inflation once you account for that; the yields are negative. I think that if you invest in fixed income, now is a tough time to find opportunities to generate that income; it's been that way for a while. I remember two years ago Bill Gross at the Morningstar Investment Conference was talking about "Well dividend-paying stocks to me look pretty attractive relative to bonds." And he is the bond kingpin.

Benz: Finally, Shannon, you want to talk about a fund that is truly flexible in terms of being able to range across asset classes. Let's talk about that fund and what the thesis is for it in the current environment?

Zimmerman: So, the fund is Leuthold Core Investment, which is a fund I am actually invested in. I don't cover it here at Morningstar, but I am invested in the fund. And it's interesting because there can be a fine line--for these funds that can lurch into and out of asset classes--between opportunism and market timing. Market timing is almost impossible to get right with any kind of consistency. How do you tell the difference? Opportunism looks much more consistent over time and it's sort of borne out by the track record. This fund hasn't had a great near-term track record but has had a remarkable run over the course of many, many years hewing to the same approach, which is a proprietary index called the major trend index that flashes signals I think across almost 200 data points, and they make portfolio asset-allocation decisions based on that index. If it gets above a certain level they dial up equity exposure. It gets below a certain level, they dial down on equity exposure, typically by hedging out through a short product that they also run inside the portfolio of core investment.

It's not the kind of fund that on paper I would even sort of give the time of day to as an analyst or even as an investor. But you look at that remarkable track record, and it catches your eye. And then you do the research, read their prospectus, the annual reports, and in my case I've been able to interview the managers a few times and think "I see. It's something that most people aren't really good at, but you've been able to pull it off with aplomb over the course of many years." It's worth paying attention to this fund. It has maximum flexibility in terms of asset allocation. It can be as high as 70% exposed to equities and as low as 30%.

Benz: So, when you look at the portfolio today, how is it positioned across asset classes?

Zimmerman: Well, you know, about this time last year it was actually pretty heavily exposed toward the higher end of its range. It could be as high, again, as 70% exposed to equities. Now it's about half of the fund's assets that constitute its net equity exposure.

Benz: The managers are value-conscious, so presumably that means that maybe they are not finding as much to buy in the equities space?

Zimmerman: That would make sense. They follow this major trend index and valuation is a key input there. They often do move toward underpriced areas of the market that they consider underpriced. They have one fund called [Leuthold Undervalued & Unloved--the ticker is UGLYX]. So, that's a part of their background as value hounds, as well.

Benz: Shannon, thank you so much for sharing three different funds, different shades of opportunism.

Zimmerman: My pleasure.

Benz: Thanks for watching. I'm Christine Benz for

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