Circling Back to Fundamental Changes Made by Five-Star Mutual Funds

• Changes to the investment strategy or the management team of an actively managed mutual fund occurs more often than investors likely realize. When such developments occur, CFRA thinks investors need the benefit of time to reflect on the performance, costs, and holdings.

• Vanguard Global Capital Cycles Fund (VGPMX) shifted in 2018 from a dedicated metals and mining fund to one providing more sector diversification. The fund’s five-star rating is driven by VGPMX’s low costs and risk mitigation efforts upon review of its holdings and recent record.

• T Rowe Price New Horizons Fund (PRNHX), another current five-star fund, underwent a management change in early 2019. Since then, it has generated a strong track record and the portfolio is filled with securities CFRA thinks are positioned favorably for the future.

While many investors are passive with their mutual funds, investment strategy or portfolio management changes require active due diligence. With mutual funds, we think investors focus heavily on the relative performance record or the expense ratio. These metrics are important, but CFRA thinks consideration of what is inside the portfolio and the tenure of management running the strategy provides important insight into the reward and risk potential of a fund. To derive our forward-looking star ratings of equity mutual funds, CFRA incorporates portfolio analytics, including using our proprietary valuation and earnings quality assets. We further include the lead manager’s tenure since we think the long-term record of a departed manager has limited value.

When a fund’s name changes, what is inside likely shifts as well. In the second half of 2018, Vanguard Precious Metals and Mining Fund was renamed Vanguard Global Capital Cycles Fund (VGPMX), with Vanguard changing to a new sub-advisor (Keith White of Wellington Management) and making a significant shift in the investment strategy. The prior approach involved investing at least 80% of assets in global metals and mining companies, with the remainder invested directly in gold, silver, or other precious metals.

The current approach still allows 25% of assets in the precious metals industry, but the remaining 75% is to be focused on companies with scarce high-quality infrastructure assets, including telecommunications and utilities, which are viewed as irreplaceable and therefore have enduring value according to management. For example, VGPMX owns CFRA Strong Buy recommended Total (TOT), an integrated oil & gas company, and Hold recommended Engie SA (ENGI), a European multi-utility, not just Buy-recommended metals and mining firms Anglo American (AAL) and Barrick Gold (GOLD). Relative to its history, VGPMX has greater sector diversification.

The fund earns a CFRA five-star rating, a much higher rating compared to other firms that rely solely on past performance. VGPMX receives very high input scores for its low costs—it has a 0.38% expense ratio that is one- third that of its peers—and extremely high scores for its risk mitigation. Many of the fund’s large positions have favorable CFRA Earnings Quality Scores that contribute positively.

Meanwhile, the lead managers of 340 equity mutual fund share classes rated by CFRA have been replaced since the beginning of 2019. Though just 3.3% of our star coverage universe, when the head portfolio manager of a widely held mutual fund leaves, investors have a right to be nervous. CFRA incorporates manager tenure as part of our risk considerations because changes to the portfolio can happen and/or the performance record might not remain as strong when a new person takes the helm.

In the first quarter of 2019, Henry Ellenbogen, the long tenured manager of small-company fund PRNHX, departed T Rowe Price and was replaced by Josh Spencer. Spencer has been with T Rowe Price for 16 years and previously managed CFRA five-star rated T Rowe Price Global Technology Fund (PRGTX). While PRNHX has a top-quartile ten-year record, most of this occurred under the departed Ellenbogen. In the one-year period ended June 2020 under Spencer’s direction, PRNHX rose 27%, significantly outperforming the 3.5% gain for its
Russell 2000 Growth Index.

PRNHX earns a five-star rating for its favorably low costs and risks as well as its strong reward potential based on a review of the holdings and the fund’s recent record. The fund holds Information Technology stocks like Booz Allen Hamilton (BAH), but is not a pure tech fund, as PRNHX has top-10 holdings in CoStar Group (CSGP) in the Industrials sector and DexCom (DXCM) in the Health Care sector. Also, despite being classified as a small- company fund, PRNHX holds some large-caps, including MSCI (MSCI) from the Financials sector. In spite of the change in management, the fund’s 46% recent turnover rate was below the 66% peer average, which indicates that Spencer did not fully revamp the portfolio upon taking over.

When an investment strategy or portfolio management change is announced by a firm provider, the easy decisions are either to ignore the news or to sell before asking questions. With a new fund rating system in place (updated in April of 2020), CFRA has been able to answer the difficult questions regarding the big changes at two equity mutual funds from Vanguard and T Rowe Price by utilizing the performance record, costs, and holdings. Currently rated as CFRA five-star funds, we think they are now positioned to outperform over the next nine months.

Todd Rosenbluth is Senior Director of ETF and Mutual Fund Research at CFRA

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