Looking to pick up a top-drawer investment on the cheap? Even the very best funds rarely consistently beat their peers, and periods of underperformance could be a buying opportunity.
You can use Morningstar tools to identify funds which fund analysts tip to outperform over the medium to long term, and fund which have had a recent bout of poor performance. Put these together and you could be looking a savvy contrarian investment.
Morningstar fund analysts award a Gold, Silver or Bronze rating to funds which they think will outperform their sector peers over the medium to long term. This is not a buy recommendation, it is up to the investor to decide whether they would like to add a particular asset class or geography to their portfolio. But once an individual – or their adviser – has identified an opportunity, fund ratings guide you to the best in class.
A Gold rating denotes that the analyst has the highest conviction in the fund, followed by Silver and then Bronze.
A fund’s star rating indicates how it has performed in recent history compared to the peer group average. If a fund has a five-star rating it has significantly outperformed its peers, if it has a one-star rating it has significantly underperformed.
If a Gold, Silver or Bronze fund has had a period of underperformance, this could be a good opportunity for long-term contrarian investors.
Using Morningstar’s free Fund Screener, we have identified three UK equity funds which fall into this category – highly rated, but performing below par. They have a Gold, Silver or Bronze analyst rating, but only one or two stars. If you are looking for an investment in these sectors, these could be a worthy addition to your portfolio.
M&G Recovery
This fund carries a Morningstar Analyst Rating of Bronze but has a one-star performance rating. Morningstar fund analyst Simon Dorricott says that this fund still holds long-term appeal despite recent underperformance.
“The fund’s relative performance has disappointed investors in recent years,” he said. “But over the longer term, since Tom Dobell took charge, the fund remains ahead of the index and is in line with the category. The fluctuation in assets under management, which ballooned from around £2.3 billion in 2009 to £8 billion in 2012 and then fell to around £3 billion last year could explain some of the muted returns over the medium term.
“In addition to stock selection and implementation issues, the portfolio has undoubtedly experienced some style headwinds, with the market generally being less willing to reward higher-risk recovery stocks than at times in the past.
“Dobell is a seasoned manager and continues to be supported by the wider resources at M&G, including the credit and corporate finance teams. We acknowledge that he has remained true to the process that has been successful in the past, and we believe the fund still has merit for long-term investors.”
Invesco Perpetual Income
This Bronze fund has a two-star performance rating. Analyst Peter Brunt says the fund benefits from an experienced manager in Mark Barnett, who is proving a steady hand despite his significantly increased responsibilities and assets under management over the past few years.
Barnett has a long-term, value-driven investment process and combines a high-level macro overview with bottom-up stock-picking. He believes that a thorough understanding of the economic framework is paramount.
“Portfolio construction is unconstrained--the manager is able to show conviction in his favoured holdings and is not tied to the benchmark. He adopts a total-return approach and, although there is an ambition to generate real dividend growth each year in this fund, he does not require a yield to invest in a stock,” says Brunt. “He will not necessarily sell a holding if its dividend is cut, but the company must be using the capital to good effect to improve its growth prospects.
“That said, Barnett does favour strong cash flows, he sees them as a good indication of a company's ability to grow dividends. Risk is considered from an absolute perspective, and Barnett spends as much time assessing downside risk as upside potential.”
Woodford Equity Income
This Silver Rated fund has had a well-documented bumpy ride over the past 12 months, following a series of stock-related headwinds. But Brunt says it remains one of Morningstar analysts’ higher-conviction ideas in the UK equity-income space.
The approach is best described as high-conviction, long-term, and contrarian in nature, and it sees him combine his macro views with bottom-up stock selection.
“While Woodford is targeting the same kind of companies as those of his Invesco Perpetual days, the overall market-cap profile has a greater tilt down the cap-scale,” says Brunt. “Unquoted investments often require a higher level of due diligence, and we believe Woodford to be well resourced in this regard.
“We also commend the firm's approach to investor relations. Communications are some of the clearest and frequent we have seen, the fees are competitive, and we find the transparency and the structure of the costs of the highest standard.”
