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Fund Spy: Morningstar Medalist Edition

Rated Funds That Win Only Half the Battle

Low fees are important, but not enough to get these rated funds a medal.

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Study after study has shown that expenses are the most reliable indicator of future mutual fund returns. But even low costs don't guarantee success. Often, low fees are not enough for an actively managed fund to earn a Morningstar Analyst Rating of Gold, Silver, or Bronze. Besides reasonable fees and a solid track record, a fund also has to have a solid, repeatable process and competent, shareholder-focused stewards at the helm. Changes or deficiencies in those fundamental traits can outweigh an attractive price tag. To illustrate, here are five funds whose low fees give them an enormous advantage over their rivals; however, they have Neutral Analyst Ratings because of questions about other critical factors.

The Vanguard name is synonymous with low fees, but that's only half the battle at two of the giant mutual fund family's actively managed quantitative funds.  Vanguard Strategic Equity (VSEQX)  and  Vanguard Growth & Income (VQNPX) are among the cheapest non-index-fund options in their respective mid-blend and large-blend Morningstar Categories. Despite that advantage, they are rated Neutral because they have yet to impress over a full market cycle.

Vanguard Strategic Equity has posted strong results in recent calendar years, but the fund still lags the Russell Mid Cap Index over the January 2006 to March 31, 2015, tenure of its most senior manager, James Troyer of Vanguard's active equity group. It has tended to stumble at market inflection points such as the 2007-09 bear market and the early stages of the subsequent rebound. For the 10-year period ended in March, the fund has delivered mid-cap stock market-like returns with average to above average Morningstar Risk ratings. Furthermore, neither Troyer nor his listed comanager, Michael Roach--also of Vanguard's active equity group--has money invested in this fund as of the most recent regulatory filings.

Vanguard Growth & Income has put up decent returns since the family restructured the fund's management in 2011. The collective goal of the fund's three subadvisors--Vanguard Active Equity Group, D.E. Shaw Investment Management, and LA Capital Management--is very modest, however. The subadvisors use quantitative models to build a portfolio that makes very small bets to beat the S&P 500, owning more than 100 more stocks than are in the benchmark in the process. Despite its very low active share, the fund's 22.1% annualized gain since the current managers took over in the fall of 2011 through March 2015 beats the large-blend category average return of 19.7% and the 21.4% of the S&P 500. So far, so good, but this collection of managers hasn't been together very long yet.

Spread Thin
Fidelity's  Strategic Advisers Value (FVSAX), a multimanager fund that also invests in other mutual funds and exchange-traded funds, is cheap but also too much of a good thing. The fund, which is available to clients of Fidelity's Portfolio Advisory Services, is cheaper than the vast majority of its peers. Its 0.54% expense ratio is lower than 85% of other no-load large-value funds. The fund also has put together a well-regarded roster of subadvisors, including T. Rowe Price, JPMorgan, and LSV Asset Management. When taken together, however, the fund spreads its money over hundreds of stocks and several mutual funds and ETFs. It's a sprawling portfolio that has done well versus its peers but not its benchmark. From its December 2008 inception through the end of March 2015, its 15.3% annualized gain beats the 14.8% of its peers but lags the 15.6% of the Russell 1000 Value Index without any significant reduction in risk.

Shuffle Mode
Manager turnover and greater risk-taking outweigh  TIAA-CREF Bond (TIBDX) and  TIAA-CREF Bond Plus' (TIBFX) low expenses. The Institutional shares of these funds are cheaper than 90% of their institutional intermediate-term bond peers'. But it's been less than four years since Joseph Higgins took over as lead manager of TIAA-CREF Bond and Bill Martin became lead manager of TIAA-CREF Bond Plus in a management reshuffling of both funds. At the same time, these offerings increased their appetites for riskier securities. TIAA-CREF Bond is still the more conservative of the two, but it can now invest up to 10% of assets in non-investment-grade bonds, up from 1%. TIAA-CREF Bond Plus can have as much as 20%-30% of its assets in high-yield bonds, emerging-markets bonds, and nonagency mortgage-backed securities. Both funds' three-year trailing annualized results were in the top quartile of the intermediate-bond category, but they still need more time to show they can consistently deliver good absolute and risk-adjusted results with their current managers in an environment less forgiving of their increased level of credit risk.

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