Morningstar Advisor - August/September 2011 - 22

Investment Briefs
Morningstar Introduces
New Mutual Fund Ratings
Morningstar will introduce analyst-driven
global fund ratings and a uniform approach for
global fund research reports in the fourth
quarter. The ratings and reports will be based
on analysts' convictions about a fund's ability
to outperform its peer group and relevant
benchmark on a risk-adjusted basis over the
long term.
The new Morningstar Analyst Rating for funds
is based on forward-looking analyst research,
whereas the well-known Morningstar
Rating for funds-the star rating-is a purely
quantitative, backward-looking measure that
rates historical performance based on risk- and
cost-adjusted returns without any input
from Morningstar's analysts. The new Analyst
Rating will not replace the star ratings,
and the existing star rating methodology will
not change. Morningstar considers the new
Analyst Rating to be an " aptitude test "
that is intended to supplement the star rating,
which is an " achievement test. " The new
ratings and research reports will replace the
Analyst Picks and Pans.
The new rating will be assigned as one of five
ratings-AAA, AA, A, Neutral, or Negative.
Analysts arrive at a rating through an
evaluation of five key pillars that Morningstar
believes are crucial to predicting the future
success of a fund: People, Process, Parent,
Performance, and Price.
If a fund receives a positive rating of AAA,
AA, or A, it means that Morningstar
analysts think highly of the fund and expect it
to outperform its peer group and relevant
benchmark on a risk-adjusted basis over a full
market cycle of at least five years. The ratings
scale is as follows:
r AAA: Best-of-breed fund that distinguishes
itself across the five pillars and has
garnered the analysts' highest level of
conviction.
r AA: Fund with notable advantages across
several, but perhaps not all, of the five
pillars-strengths that give the analysts a high
level of conviction.
r A: Fund with advantages that outweigh
any disadvantages across the five pillars,
with sufficient level of analyst conviction to
warrant a positive rating.
r Neutral: Fund that isn't likely to deliver
standout returns but also isn't likely to
significantly underperform.
r Negative: Fund that has at least one
flaw that is likely to significantly hamper future
performance and is considered an inferior
offering to its peers.
sheets are reflected in its aggregate debt/
equity ratio. The fund invests 75% of assets in
firms that pay dividends, too, a requirement
that reinforces the portfolio's tilt toward
financial strength. But the large-blend vehicle's
quality bias has dragged on performance during
the risk-led rally. The fund delivered middling
relative returns in 2009, sank to the large-blend
category's bottom decile in 2010, and has so far
turned in a subpar 2011 as well.
Zimmerman says that quality's lackluster
showing may present an opportunity. " Given
the rapid rise of riskier fare, " he says,
" now may well be an excellent opportunity
to have your quality cake and eat it, too. "
High Quality, Low
Rewards
During the stock-market rally that's been under
way for more than two years, " quality "
has been a performance detractor, according to
mutual fund analyst Shannon Zimmerman.
Bridgeway Blue Chip 35 Index BRLIX, for
example, has been an underachiever the past
two years. The large-blend fund holds
37 companies, and according to Morningstar
equity research, all but one boast economic
moats. Thirty of its holdings receive
Morningstar Financial Health Grades of B or
higher, too. Yet the fund fell a bit below
the category's midway point in 2009, finished
near the bottom decile in 2010, and has
remained there thus far in 2011. This certainly
isn't a phenomenon that's unique to Bridgeway,
and the shop's latest shareholder report
sums up the widespread dynamic succinctly:
For an unusually lengthy stretch, many
companies' superior economic performance
and fundamental strength simply haven't led to
superior stock-price appreciation.
Parnassus Equity Income PRBLX is struggling
through a similar set of circumstances.
The fund's socially screened lineup mainly
comprises companies whose healthy balance
22 Morningstar Advisor August/September 2011
Dividend Funds That Live
Up to Their Names
Mutual fund analyst Greg Carlson tracked
down several stock funds with a consistent
record of paying above-average dividends
that also have experienced skippers and solid
track records:
Vanguard Equity-Income VEIPX
This large-value fund recently had a healthy
12-month payout of 2.44% and a one-month
yield of 2.72%. It doesn't attempt to
boost its yield by holding distressed companies.
Michael Reckmeyer of Wellington Management
(who runs 60% of the fund) and
Vanguard's quantitative investing group (which
manages the rest) typically stick with
companies that have solid balance sheets and
generate plenty of cash. It has been a winner
over the short and long haul, and its low
0.31% expense ratio lets more of its holdings'
dividends flow through to shareholders.
Allianz NFJ Dividend Value PEIDX
Much like the Vanguard fund, this one focuses
on cheap dividend payers. The management
team here also favors financially sturdy
companies, as evidenced by the portfolio's
below-average debt/market-capitalization ratio.
Morningstar Advisor - August/September 2011

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