These Funds Are Better Than Their Low Star Ratings

The Morningstar Rating for funds and the Morningstar Medalist Rating are geared toward very different things. The star rating is a backward-looking measure of risk-adjusted performance over the past three-, five-, and 10-year periods. It’s purely quantitative; Morningstar analysts don’t have any say in it. The Medalist Rating is a forward-looking rating that reflects our outlook for key fundamentals such as people, parent, process, and expense ratio. Analysts do extensive research and talk to managers and others at a fund company to develop a complete picture of a fund before rating it. The Medalist Rating does have quantitative parts to it, but they are not driven by the fund’s past performance.

Although the two rating systems tend to be broadly in sync, there are times when they diverge by having a fund highly rated in one system and rated poorly in the other. To underscore that point, I have selected four low-star funds that have Silver or Gold ratings. Generally, you’ll see something like this because the fund’s strategy is out of style or has relatively high volatility—something the star rating punishes pretty severely. Yet, it doesn’t take a lot of time for a fund to get back in favor, so we stay patient. Three of the four funds I’ve chosen have below-average 10-year results but stellar 15-year results, reflecting management’s skill over the long haul even if recent history has been challenging.

Still, the fact these funds could stay out in the cold for an extended time suggests that investors should be careful about making them big positions in their portfolios.

Loomis Sayles Strategic Income’s NEFZX Morningstar Rating popped up to 2 stars from 1 star in April after this article was first published in the March issue of Morningstar FundInvestor, but there’s still a pretty big gap between its Medalist Rating and star rating. The Silver-rated fund has been out of favor for a surprisingly long time. Its 10-year returns are bottom-decile, but its 15-year returns are top-quartile. The fund’s aggression has worked against it as high-yield and non-US-dollar exposures have sometimes hurt the fund. Although manager Dan Fuss has retired, we still think this team and process have what it takes. The fund had a solid 2023 and has the right profile for more years like it.

One-star-rated Oakmark International OAKIX will always be in the cellar or penthouse owing to its focused value portfolio. Lead manager David Herro has strong long-term returns even though recently they have been weak. He looks for stocks trading at big discounts and doesn’t worry much about country and sector weights. European banks are once again hurting returns in 2024. And the fund has just often been out of sync with the market. It was too economically sensitive in the coronavirus selloff and lacked energy exposure to participate in the rebound of oil prices that followed the economic recovery and Russia’s invasion of Ukraine. Still, we trust Herro’s judgment at this Gold-rated fund and expect better results over the next 10 years.

Before you buy 1-star-rated Morgan Stanley Institutional Growth MSEGX, be sure to check out the roller-coaster ride through calendar-year returns: 115.09% in 2020, 0.16% in 2021, negative 60.44% in 2022, and 49.87% in 2023. Yes, lead manager Dennis Lynch invests in fast-growing companies that sometimes crash and burn. He’s a patient investor, almost like a venture capitalist, and the idea is that a few winners make up for quite a few losers. Aggressive names like Cloudflare NET, Snowflake SNOW, and Tesla TSLA populate the portfolio. Used in moderation, this can provide a kick, but don’t get carried away with this Silver-rated fund.

Vanguard Long-Term Bond Index VBLAX is rated Silver but has 1 star because it packs a lot of duration risk. So much that it lost 27% in 2022 but gained 19% in 2019. If you have low-duration funds, this fund is a nice complement. It owns Treasuries, mortgages, and investment-grade corporate debt that matures in 10 years or more. The fund has a cheap 0.07% expense ratio. The good news is that we have already had an interest-rate shock, so the future looks brighter than the recent past.

This article first appeared in the March 2024 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting this website.