Lack of ratings, track records not deterring investors

For mutual funds, having a rating and at least a three-year track record may not be quite as important anymore.

Unrated mutual funds with track records of less than three years gained $109.5 billion in net inflows over the 12-month period ended March 31, according to Morningstar Inc. That is close to what funds with four- and five-star ratings from the fund tracker netted, and more than all lower-rated funds.

A big part of the reason that new funds have done well is that established players such as American Funds, Fidelity Investments, Pacific Investment Management Co. LLC and The Vanguard Group Inc. have come out with new products or additional share classes of existing funds which aren’t yet rated but have garnered assets anyway.

Newer alternative strategies also have been attracting big money. It is in buying these less tested funds, sometimes run by upstart managers, that financial advisers need to tread carefully, observers said.

Unrated funds include a mix of strategies and asset classes, including various bond funds, foreign-equity funds, commodity-related products, world allocation funds and diversified emerging-markets funds, said Loren Fox, a senior research analyst at fund researcher Strategic Insight.

Those areas “have been hot overall in the mutual fund world,” he said.

The biggest gainer among all open-end funds for the 12-month period ended March 31 was the DoubleLine Total Return Bond Fund (DBLTX), a relative newbie, which raked in $15.4 billion, according to Morningstar.

Advisers have flocked to the fund based on manager Jeffrey Gundlach’s impressive performance since its launch in April 2010, on top of his solid previous record in managing the TCW Total Return Bond (TGLMX).

Along the same lines, the Pimco CommoditiesPlus Strategy Fund (PCLIX) attracted a net $2.2 billion over the same 12-month period, according to Morningstar. “Investors probably have confidence in Pimco’s ability to meet its benchmark,” based on the track record of the fund’s older sibling, the Pimco Commodity Real Return Strategy Fund (PCRIX), said Michelle Canavan, a mutual fund analyst at Morningstar.

Newly introduced share classes of existing funds have brought in significant flows for American Funds, Fidelity, Russell Investments and Vanguard, analysts said.

These new classes aren’t rated.

Funds that use alternative strategies, such as foreign currencies, broad baskets of commodities or managed futures, took in estimated net flows of $19.3 billion in the 12-month period ended March 31, according to Morningstar.

NEW ISN’T A NEGATIVE

Many of these products have come out in the past three years.

“There are investors out there who are amenable to switching out of the tried-and-true to the unproven and new,” said Jeff Tjornehoj, head of Lipper Americas Research, which, like Morningstar, requires three years of performance before rating a fund.

Investors and advisers don’t always feel the need to wait for three-year results “because they’re obviously looking at the funds on their own and deciding they want exposure to [a new] asset class,” Mr. Fox said.

Chris Bray, managing director at Willow Street Advisors LLC, which manages about $240 million, has been skeptical of illiquid hedge-fund-type strategies in particular.  But with more products available through mutual funds, he said that he is looking closely at them.

“We think [some of the new products] are a good idea, but we want to see how things play out with them longer-term,” Mr. Bray said.

“VERY SKEPTICAL’

“Let’s face it — a lot of asset flows do flow to fads,” he said. “Advisers want to be able to talk about something new and sexy.”

Advisers and their clients are “all gearing up to fight the last war,” said Chris Cordaro, chief executive of RegentAtlantic Capital LLC, referring to the flight to safety following the financial crisis.

Mr. Cordaro, whose firm manages about $2.2 billion, counts himself as “very skeptical” of any new fund based on a strategy that boasts of back-tested performance or that has even been proved in a separate-account or a limited-partnership structure.

“Once you put it into a mutual fund, you have all these issues of flows coming in, which is very challenging,” he said.

Furthermore, new mutual fund strategies come out only after they have done well, and risk reverting to the mean, Mr. Cordaro said.

“You’re probably getting into it at the wrong time,” he said.

Jack Firestone, president of Firestone Capital Management Inc., shares those concerns but said that he has always been willing to try new mutual funds.

“We use the same criteria as in choosing any other fund: Who’s the management team, what is the process, has the process itself been utilized before, and what [was] the result?” he said.

Mr. Firestone said that he has done well by being an early investor in the MainStay ICap Select Equity Fund (ICSRX) and the Pimco All Asset All Authority Fund C (PAUAX).

[email protected]