Manager Switch, Impending Distribution Spark Change in Bucket Portfolios
American Funds International Growth and Income is a sensible international pick for retirees.
Harbor Funds made some major news in the mutual fund world recently.
The firm announced it was replacing longtime subadvisor Northern Cross with Marathon Investment Management at Harbor International (HIINX), a holding in my Model Bucket Portfolios for retired investors. Additionally--and relatedly-Harbor expects the fund to make a capital gains distribution of between $23 and $27 per share later this year. That amounts to a whopping 37% of the fund's current net asset value. The fund has seen staggering redemptions amounting to an estimated $27 billion over the past three years, and those redemptions are likely the biggest driver of the distribution. (Senior analyst Kevin McDevitt discussed the news here.)
When funds see outflows of that magnitude, that often forces management to sell long-held, highly appreciated positions, which in turn results in capital gains distributions. My Model Bucket Portfolios are geared toward investors' tax-deferred accounts, such as IRAs, and I've developed a separate set of Bucket portfolios geared toward retired investors' taxable assets. Additionally, Harbor International hasn't been officially downgraded by Morningstar's analyst team; the fund is currently under review, and a new rating should be available soon.
Nonetheless, the combination of recent news prompted me to swap Harbor International for a different international fund for the Bucket portfolios: American Funds International Growth and Income (IGIFX). After consulting with our analyst team, I decided that that fund's value tilt and focus on dividends makes it a good fit for the Bucket portfolios, which are geared toward people who are already retired. And while some investors assume that American Funds are only available with sales charges, that's no longer the case: The F1 share class of the firm's funds is available without a load or transaction fee through major brokerage firms like Schwab, Fidelity, and Vanguard.
Harbor International has detracted from the portfolios' performance since their launch six years ago, underperforming both the foreign large-blend category average as well as the MSCI ACWI Ex-US Index during that time frame. But that's a fairly short time period by which to judge, especially given that the Northern Cross team in charge maintained an extremely long-term mindset for their investments. (Portfolio turnover was typically very low.) And in any case, the international-stock position in my Model Bucket Portfolios isn't huge, ranging from 15% for the Aggressive version to 10% for the Moderate portfolio to just 7% for the Conservative one. Thus, I was comfortable standing pat with the fund for the portfolios, despite the underperformance.
Nonetheless, McDevitt had been keeping an eye on its volatility, as well as the fact that the fund hadn't distinguished itself on the performance front since longtime manager Hakan Castegren died in 2010. In a research report from October 2017, he noted that noted that some of management's opportunistic bets had weighed on performance, including an ill-fated bet on basic materials stocks. The fund was downgraded to Silver from Gold at that time.
Morningstar's analyst team is revisiting that rating in light of Harbor's decision to replace Northern Cross with Marathon. In his note about the change, McDevitt notes that the Marathon team also runs Harbor Diversified International All Cap (HAIDX), where they've generated mediocre results since that fund's 2015 launch. The team also oversees a component of Vanguard Global Equity (VHGEX), but its multimanager setup makes it difficult to disentangle their contribution to performance.
A Bit About American Funds International Growth and Income
Ultimately, the combination of the management change, the shareholder redemptions, and the impending capital gains distribution prompted my decision to replace Harbor International with an offering in which our analyst team has a higher degree of conviction.
My initial temptation was to swap in a total international stock-market index fund, and that's still a viable option for investors who'd like to reduce their portfolios' expenses as well as their oversight responsibilities. (Investors in index funds don't have to worry about the kind of management upheaval that recently rocked Harbor International.) A total international index fund is certainly the better option for taxable investors, and I've gone that route in my Bucket portfolios for tax-sheltered accounts as well as in my ETF Bucket portfolios.
Yet in discussing some of the options with Morningstar's analyst team, I was compelled by the strategy and team in place at American Funds International Growth and Income, a Gold-rated foreign large-blend fund. While it typically maintains a higher emerging markets stake than its average peer, it focuses on companies that pay dividends and have reasonable valuations. It's also reasonably low-turnover and well-diversified, and its multimanager setup should help ease any succession issues. Trailing performance relative to the peer group looks merely so-so, in part because of its hefty emerging markets stake, but its volatility as measured by standard deviation and Morningstar's risk rating is below average.
American Funds International Growth and Income is also cheaper than the Harbor offering: The F1 shares, which are available without a load or transaction fee on brokerage firm menus, levy an expense ratio of 0.97%, versus 1.09% for the retail share class of Harbor International.
Tax Considerations Are Paramount
The Model Bucket Portfolios are designed mainly for educational purposes rather than to be mirrored holding by holding. But investors who hold positions in Harbor International may be pondering whether to make a switch in light of the recent news.
I'd put tax considerations front and center in that decision: Investors who hold Harbor International in a taxable account will likely face a tax bill whether they exit the fund or stick around. As noted earlier, the fund is expected to make a sizable capital gains distribution this year; if redemptions continue, further distributions could be in the offing. Meanwhile, shareholders who exit pre-emptively will owe capital gains on any appreciation they've earned during their holding periods. (Investors who are in the 0% tax bracket for capital gains will obviously be able to skirt both types of taxes.)
Investors in tax-sheltered accounts, on the other hand, have the latitude to make decisions based on investment merit alone. Harbor Capital Advisors, which oversees the management of Harbor International and other Harbor funds, has historically done an excellent job selecting and overseeing managers; it has also typically been quite patient in its approach. On the other hand, Morningstar's manager research analysts currently have seven core foreign-stock funds that earn Gold ratings, and American Funds International Growth and Income is one of them.
Christine Benz does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.