3 Funds That Are Worse Than They Look
Don't let these funds' stellar recent returns obscure their underlying deficiencies.
Susan Dziubinski: In a video that aired a couple of weeks ago, we examined three funds that were better than they looked. All three had lousy star ratings but strong fund analyst ratings. Today, we're doing just the opposite. We're looking at three funds that aren't as good as they might first look. These funds all earn 5-star ratings but just Neutral fund analyst ratings.
Robby Greengold: Fidelity OTC is a large-cap growth fund that currently earns 5 stars. That's a reflection of excellent historical performance relative to its category. For example, the fund beat 95% of its category over the past five years. And that outperformance is mostly attributed to bold bets made at the stock level. For example, the fund held a hefty stake in Tesla from 2016 to mid-2017. That was an excellent time to be in the stock.
And there have been been other examples of stellar stock-picking as well, but the manager responsible for those picks is no longer at the firm. The strategy is now in the hands of Chris Lin, who is a seasoned tech analyst but lacks experience running a diversified portfolio. And this is a big strategy with more than $20 billion tied to it. That explains our Morningstar Analyst Rating of Neutral. Lin hasn't proven himself yet on a strategy of this size and scope. We're waiting to see how he tackles portfolio construction, how well he manages risk, and how he executes day to day on this mandate that is still new for him.
Connor Young: Neutral-rated MFS Core Equity is an analyst-run fund. The analyst team that picks stocks here is deep in experience, but the investment approach in place has no clear advantage. The portfolio's industry weightings are kept in line with those of the Russell 3000 Index. While the analysts, who each focus on particular industries, select stocks to fill their industries' weightings in the portfolio.
This industry-neutral approach limits the strategy's sources of excess return when compared with other offerings that benefit from skilled managers and more flexible mandates, including many offered by MFS that tap this research team to a great degree.
And to be sure, the strategy has delivered great results but has a pronounced growth tilt, and that's been a significant advantage as growth stocks have led the way recently. It's uncertain whether this fund could replicate its success in a less growth-oriented environment. Plus, middling fees provide no advantage.
Nick Watson: Neutral-rated Delaware Smid Cap Growth has delivered impressive absolute returns over lead manager Alex Ely's tenure. But its aggressive growth portfolio has delivered it's share of ups and downs. Ely and his team invest in fast-growing firms and have a tolerance for high valuations. It's significantly more growth-oriented than the Russell 2500 Growth Index and the typical small-growth Morningstar Category peer.
And with 30 to 40 names, it courts a considerable amount of stock-specific risk. The fund's growth orientation has helped it recently, but that hasn't always been the case. In the second half of 2016, for instance, when value stocks were in favor, the fund lagged the Russell 2500 Growth Index by 15 percentage points. That sort of volatility has been characteristic over Ely's tenure, especially in down markets, where the fund has tended to lose significantly more than the index. The volatile pattern of performance suggests that this is a fund that would likely struggle to navigate an inflection point in the market.
Susan Dziubinski does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.