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Fund Spy

Investors Are Going the Wrong Way on These Funds

Six good funds are hit with outflows, but three small good funds are seeing inflows.

This is an excerpt from the July 2017 issue of Morningstar FundInvestor. Data have been updated through July 2017. Download a complimentary copy of Morningstar FundInvestor by visiting the website.

Generally, investors are going in the right direction. They are buying well-run low-cost funds and selling high-cost failures. But that’s not always the case. Investors also tend to lean too heavily on short-term performance. There are some funds where you should not follow the crowd.

I found very good funds with poor three-year returns, and some mediocre funds with strong three-year returns. A three-year figure tells you more about luck than skill, yet fund flows imply that it’s really all skill. But that’s something you can use to your advantage. I looked at funds whose one-year organic growth rates (net flows as a percentage of assets at the beginning of the year) signal that investors are headed in the wrong direction. 

Keep the Faith in These Funds
 FMI Large Cap (FMIHX), with a Morningstar Analyst Rating of Gold, seems to have attracted a fickle crowd. The fund’s three- and five-year returns are a bit below the large-blend Morningstar Category median, but its 10-year returns of 8.2% remain in the top 10%. Yet more than $2 billion has fled the fund in the past 12 months. We remain confident in the Milwaukee-based team, led by Pat English. With a focused portfolio, some bumps are to be expected. The team members look for cheap stocks with high returns on invested capital. Lately, they’ve been adding to holdings such as  Unilever (UL) and  AmerisourceBergen (ABC). These aren’t thrilling names, but they are high-quality companies that should hold up well in the next downturn. 

 BBH Core Select (BBTEX) is another focused, quality stock fund that has fallen out of favor. Outflows led it to reopen to new investors, and this looks like a good chance to get in. Managers Tim Hartch and Michael Keller seek out companies with strong balance sheets, healthy cash flow, and high returns on cash flow. Although that typically leads to great companies, the fund hasn’t been in sync with the market of late. Yet, over Hartch’s tenure, it has easily outpaced the Russell 1000 Index with less risk than the market. 

 Artisan Small Cap (ARTSX) has seen $450 million go out the door, but we rate it Silver. We like lead manager Craigh Cepukenas and the growth team that he joined in 2009. He’d been a comanager since 2004 but moved to the growth team led by Andy Stephens. Cepukenas kept the fund’s emphasis on earnings growth, but added a couple of strategic wrinkles from his new growth team: greater conviction in top names and an aversion to cyclical names. Although performance has been middling, the fund enjoyed a nice rally in the first half of 2017. I’ll be interested to see if the fund reopens in the near future. 

 Litman Gregory Masters International (MSILX) has shed $337 million largely because of losses in 2015 and 2016 that were driven by European financials and an underweighting in Japan. The Bronze-rated fund has recouped some ground with a 16% return in the first half of 2017 that owes to some of the same factors that hurt it the previous two years. The fund is run by five subadvisors that each select eight to 15 names for the portfolio. It’s a strong group led by Harris Associates’ David Herro; Northern Cross veterans James LaTorre, Howard Appleby, and Jean-Francois Ducrest; and Lazard manager Mark Little. Despite the slump, the fund still has a solid long-term record. 

 AllianzGI NFJ Small-Cap Value (PCVAX) has really shrunk. The fund lost $1.6 billion in outflows, and we downgraded its rating to Bronze from Silver. The managers have stayed true to their knitting, but stock selection has left them behind. On the plus side, we like their mix of deep value and dividend quality as well as their consistency in process if not performance. 

 RiverPark/Wedgewood (RWGFX) shed $1 billion, or nearly half its assets under management, because the Bronze-rated fund has faltered after a promising start. The fund had two great years in 2011 and 2012 right out of the box, but slumped the following three years. When younger funds hit a slump, they tend to get hit hard with redemptions because they haven’t built up much loyalty among shareholders. David Rolfe’s focused growth investing leans to lower-priced fare than that favored by Touchstone, so the fund is slumping once again in 2017. Value plays like  Schlumberger (SLB) and  Qualcomm (QCOM) have been duds. Rolfe’s cautious growth strategy has produced solid long-term results in his separate accounts, which go back many more years than this fund, so we still have confidence in the fund. 

Where the Crowd Is Right
Sometimes the trend does go in the right direction. I flipped the tables by looking for funds with the highest organic growth rates that are also Morningstar Medalists. Many of those that turned up on the list have pretty small AUM, so I’m not worried about them getting swamped. Still-small  Ariel International (AINTX) has doubled in one year’s time, but Rupal Bhansali’s Bronze-rated fund is only $470 million total. She invests in an unusual focused portfolio of quality stocks, including some off the beaten track. Her goal is low risk and solid returns, so Bhansali looks for clean balance sheets and strong franchises. 

Brian Schaub and Chad Meade, managers of Bronze-rated  Meridian Small Cap Growth (MISGX), are getting notice as investors follow them from a strong run at  Janus Henderson Triton (JATTX). The fund has seen $433 million in inflows but is still under $1 billion in total. 

We’re on board with sending more money to  Fidelity Large Cap Stock (FLCSX) and manager Matt Fruhan. The Silver-rated fund has grown 62% but is still a manageable $4.8 billion. He looks for low-valuation stocks where Fidelity projects earnings growth greater than Wall Street consensus. This gives the fund a distinct value bias for a blend fund, but more importantly, returns have been ahead of peers and the benchmark since Fruhan took over in 2005. 

Silver-rated  Champlain Mid Cap (CIPMX) grew by about $350 million in the past 12 months as Scott Brayman’s team has built a strong track record at the fund with a process that seeks out stable growers with high returns on equity. The fund recently cut fees so that costs are decent, though not great. We also like Brayman’s attention to capacity. He says he’ll shut this fund when the strategy hits $5.0 billion (mutual fund and separate account assets combined). It is currently around $4.5 billion, so it may not be open to new investors next year.

 

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