Morningstar Advisor - April/May 2009 - 20

Investment Briefs Tough Times Reveal Funds’ Weaknesses Mutual fund losses have run across the board, but Karen Dolan, Morningstar’s director of fund analysis, has taken a closer look and found three funds that should have done better in tough times. Janus Worldwide JAWWX Morningstar analysts became fans of Janus Worldwide soon after manager Jason Yee took over in 2004. Times were tough from the get-go, however, as Yee positioned Worldwide conservatively when emerging markets and energy drove its peers and several Janus siblings to big gains. It was expected that the fund would eventually have its day in the sun when speculation lost its attraction and the market’s favor rotated out of emerging markets and energy. Risk-taking is no longer in favor, and the market has indeed punished emerging-markets and energy stocks, but this fund continues to lag. Artisan Small Cap ARTSX As at Worldwide, this fund’s managers employ a sensible strategy that emphasizes fundamental attributes. Those inclinations are good in theory but haven’t led to the expected results. The fund lagged while cyclical commodityoriented stocks rallied because those kinds of companies are less likely to fit the managers’ criteria. The preferences that held the fund back in the cyclical boom, however, failed to protect it in the market’s carnage in the second half of 2008 when highly cyclical—and highly leveraged—businesses were crushed. The fund’s holdings proved to be more vulnerable than the managers thought. The fund hasn’t performed well in most rallies and has now failed to protect capital at a crucial time. Western Asset Core Bond WATFX This fund has been burned by 2008’s severe credit-sector and mortgage troubles and some missteps in its team’s core competency— credit analysis. Several corporate-bond issuers in the portfolio, such as Lehman Brothers and Iceland’s Kaupthing Bank, Glitnir Banki, and Landsbanki, are now in default. The fund’s stake in nongovernment mortgage-backed securities (roughly 20% of assets) has weighed on performance as well. Further exacerbating those bad calls, shareholders have been calling it quits at an alarming pace. Add firm-level challenges to that mix, and things don’t look good. from six months to a year, and it is marked by widespread contractions in many sectors of the economy. According to the NBER, the current recession is one of the longest since the Great Depression. Furthermore, only two of the previous 10 recessions lasted as long as a full year. While it is anyone’s best guess as to when the recovery period will commence, it helps to look at which stocks, large or small, have led the way out of previous recessions. According to Morningstar researcher Jim Licato, history reveals that small stocks have been one of the strongest performers after recessions. The image below shows that, on average, the cumulative returns of small stocks outperformed large stocks one month, six months, one year, and three years after the end of a recession (the past 10 recessions were analyzed). Small stocks haven’t outperformed large stocks after every recession, yet on average their potential to prosper is significant. In general, it has been shown that diversifying into small stocks may benefit your clients’ portfolios. Stock Performance after Recessions: Cumulative Returns of Large and Small Stocks after Recessions 1946-2008 80% 60 40 20.1 20 2.2 3.8 After 6 months After 1 year After 3 years After 1 month 11.4 19.1 33.7 Large stocks Small stocks 74.0 401(k) Outflows Create ETF Opportunities In the February issue of the Morningstar ETFInvestor newsletter, ETF analyst John Gabriel sees a rush of opportunity for ETFs— in the form of newly converted IRAs. Some of the 78 million baby boomers will presumably retire and look to roll over their 401(k)s, Gabriel says, and the massive number of layoffs amid the current recession could mean that as much as 10% of the 401(k) market could “hit the street,” so to speak. Savvy advisors can capitalize on this by educating clients about the advantages of ETFs. If investors are looking to park their money in low-cost, transparent, and liquid securities, ETFs fit the bill. And while transaction costs are an argument against ETFs when investors are considering frequent and small contributions, large ETF investments make 80 plenty of sense for large, one-time rollovers. 60 40 47.7 Small Beats Big20 After Recessions 0 In December 2008, the National Bureau of Economic Research announced what most already knew—the United States has officially been in a recession since December 2007. While some may define a recession in terms of two consecutive quarters of decline in real GDP, the NBER’s definition constitutes a recurring period of decline in total output, income, employment, and trade usually lasting Large stocks in this example are represented by After 500; After months After 1 year After the S&P1 month small6 stocks are represented3 years by the fifth capitalization quintile of stocks on the NYSE for 1945–1981 and the performance of the DFA U.S. Micro Cap Portfolio thereafter. The average cumulative returns are calculated from the end of each of the previous 10 recessions in U.S. history. 20 Morningstar Advisor April/May 2009

Morningstar Advisor - April/May 2009

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