Morningstar Advisor - Summer 2008 - 18

Investment Briefs Good Stewardship Good for Funds Shareholder-friendliness is good for business. Morningstar managing director Don Phillips and mutual fund analyst Laura Pavlenko Lutton recently looked at mutual funds’ estimate net asset flows by Morningstar Stewardship Grade. They determined that funds with Stewardship Grades of A at the end of 2007 typically had asset increases of more than $800 million since 2004, while funds that got D’s and F’s had shrinking asset bases, on average. These trends suggest that shareholders value good stewardship. The results are somewhat skewed by the fact that some of the industry’s largest funds earn grades of A and B. American Funds’ offerings, which have earned mostly B’s, have attracted billions in new assets in recent years. The Vanguard funds—which have gotten mostly A’s and B’s—have also been big sellers, as have the Dodge & Cox funds, which earn A’s for shareholder-friendliness. Conversely, the funds that sport lower Stewardship Grades are having a tough time raising assets. Many funds that earn low grades have seen redemptions from shareholders in recent years. This list includes offerings from Invesco AIM, Federated, and Putnam. of the funds with A’s and more than 50% of the funds earning B’s also have generated peer-beating, risk-adjusted returns over the long term. On the flip side, just one fourth of the funds with D and F grades have demonstrated that high level of performance. Lutton pointed out, though, that the funds that have grown the most in recent years generally are stable and well run, generating strong returns with prudent strategies. They haven’t drawn assets by means of flashy advertising campaigns or by using high-risk strategies to goose returns, as was seen among the best-selling funds in the late 1990s. Tessera Technologies TSRA The unstoppable trend toward miniaturization that Tessera’s chip-scale packaging technology enables and its success in using the courts to extract revenue from chipmakers much larger than itself are two reasons we think Tessera Technologies is a good high-tech investment for the more adventurous. Penn National Gaming PENN Acquisitions and favorable legislation have helped transform Penn from a small racetrack outfit into the nation’s fourth-largest casino operator. However, uncertainty surrounding the company’s pending buyout has put a dark cloud over the firm’s shares. Posco PKX Posco’s technological leadership, low-cost production, and proximity to the world’s fastest growing steel markets serve the company well as it strives to solidify its leading position in the global steel industry. Posco should continue to benefit from the global steel demand upturn for the foreseeable future. Better Days Ahead for These Five Firms? Morningstar stock analyst Michael Tian knows that finding companies on the brink of a turnaround is no easy feat. With this in mind, he went looking for beaten-down stocks that have a chance at a comeback. He searched for companies that have at least a narrow economic moat, as well as operating income growth of at least 10% per year and return on equity of at least 15% per year for the three years previous to the most recent year. He highlighted five interesting prospects that matched his criteria at the end of June: Zimmer Holdings ZMH Zimmer stands out in a very attractive industry. It leads several key orthopedic device categories that possess high barriers to entry and sticky physician relationships. Morningstar analysts think these positive attributes, combined with Zimmer’s manufacturing and marketing prowess, will help the firm generate excellent returns for the long run. Quest Diagnostics DGX Quest and its only national competitor, LabCorp, dominate the independent diagnostic testing landscape. Both firms leverage vast national networks of laboratories and patient testing centers, creating barriers to entry and giving them cost advantages over regional labs. Check that Stake in Emerging Markets With emerging markets producing strong returns in recent years, investors should not lose sight of their target asset mix, says Jim Licato, Morningstar’s research and communications manager. Otherwise, they could hold unbalanced, riskier portfolios. The MSCI Emerging Markets Index produced double-digit returns over each of the past five calendar years, equating to a five-year compound annual return of 37.8%. Over the past 10 and 20 years, the index generated compound annual returns of 19.1% and 16.3%, respectively. With higher returns, however, comes additional risk, and it is important to note that emerging markets have historically been more volatile than their developed counterparts, in line with the risk/return trade-off. Portfolios that include Asset Growth by Morningstar Stewardship Grade Stewardship Grade Average Asset Growth per Fund, 2007 Average Asset Growth per Fund, 2004–07 Z X C V B Morningstar data $181.7M $103.0M $2.2M –$12.3M –$8.5M $839.6M $490.7M $39.6M –$66.9M –$20.1M Critics might say that these trends are tied to performance-chasing, and that could be the case: Most of the funds earning A’s and B’s have strong long-term records. Nearly 75% 18 Morningstar Advisor Summer 2008

Morningstar Advisor - Summer 2008

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