3 Funds with Surprising Red Flags

01/04/2012 8:15 am EST

Focus: FUNDS

What used to be the gold standard in mutual funds now have lost more than their luster over recent years, writes Gregg Wolper of Morningstar FundInvestor.

The Morningstar Analyst Ratings debuted last month, and some investors likely were surprised by the luke­warm ratings given to what once were among the most prominent and successful funds around.

In the cases discussed below, the modest ratings owe largely to concerns about their management situa­tions. But the nature of those concerns varies with the fund.

It’s important to note that these funds all received Neutral ratings, not the lowest rating of Negative. The Morningstar 500 does not contain any funds with Negative ratings.

Fidelity Magellan (FMAGX)
Although the Peter Lynch legacy has receded further and further into the past, this fund still receives atten­tion from the media, and still has about $17 billion in assets.

Its unimpressive performance over the past three-, five-, and ten-year periods does not entirely explain its modest Neutral rating, however. After all, the managers responsible for those returns are gone.

As noted in the October issue of Morningstar FundIn­vestor, the latest change took place in September, when Harry Lange was replaced by Jeff Feingold of Fidelity Trend (FTRNX). We had Magellan penciled in for a Negative before the change.

Feingold has amassed a solid record on Trend. So, why not award this fund a positive rating, such as Bronze or Silver, especially considering its expense ratio is reasonable compared with those of peers? The main reason is that Feingold now has to deal with a much larger asset base than he has ever managed before, which raises a good deal of uncertainty. Running a huge asset base raises significant challenges.

In addi­tion, the manager change means the fund’s strategy will also change, but how it will be run—exactly like Trend or with some adjustments—remains to be seen. Also, this fund receives a Neutral rating for Parent, which is another factor in the overall rating.

Columbia Value & Restructuring (UMBIX)
Unlike Magellan, this fund has a great long-term record. So, readers might assume that its Neutral rating owes to its poor 2011 performance: It has lost 8.6% through November 30, landing in the 93rd percen­tile of the large-value category.

But that’s not it. In fact, of the five Pillars used to calculate the overall rating, this fund receives its only Positive in the Performance area.

The manager who has led the fund throughout its impressive 19-year history, David Williams, has stated he will retire at the end of 2012. His current co-managers are slated to take over. That provides some reassurance, for one has worked with Williams since 2005. But they’ve only been listed as co-managers since 2009.

They say they will use the same strategy that has brought the fund success, but it’s an unusual approach, so actually sticking with it over time—and moreover, succeeding with it—will be a challenge. Meanwhile, the fund doesn’t score highly in either the Parent or Price components of the rating. An overall Neutral rating is the result.

Vanguard Windsor (VWNDX)
As Magellan conjures up memories of Peter Lynch, this one will always be associated with John Neff, the legendary manager who brought it remarkable success for 31 years until his retirement in 1995. Now though, the fund is run by two sub-advisors.

Wellington Management runs 70% of its assets and is solid, but it’s hard to have confidence in the AllianceBernstein team that oversees the remainder of the portfolio, for the composition of that team has been in flux for years.

Meanwhile, the fund’s performance in the post-Neff era has been unremarkable. Its ten- and 15-year returns land around the middle of the large-value category, and it has been more volatile than the norm. In short, while this fund has a low cost and an excellent Parent in Vanguard, that’s not enough to lift it out of Neutral territory.

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