Karin Anderson is an associate director of fixed-income strategies for Morningstar.
To find some promising funds that can diversify an index-heavy portfolio, we used Morningstar's Premium Fund Screener
. We narrowed our search to the domestic-stock, international-stock, and taxable-bond categories. Because we're looking at such a broad group, we focused the screen on the three-year R-squared measure, which represents the percentage of a fund's movements that can be explained by movements in a benchmark index. On Morningstar.com, R-squared compares all equity funds to the S&P 500 Index and all fixed-income funds to the Lehman Brothers Aggregate Bond Index. (An individual fund's R-squared can be found under the "Risk Measures" tab of each Fund Report.) An R-squared of 100 indicates that the fund's performance moves in tandem with that particular index.
For this screen, we looked for funds that have an R-squared of 80 or less relative to each fund's broad market index as well as to its best-fit index. Morningstar calculates each fund's best-fit index by comparing its excess returns to the excess returns of several well-known market indexes. The fund's best-fit index is the market index that has shown the highest correlation with a fund over the most recent 36 months. True, this is a relatively short timeframe to use for managers who actively adjust a fund's stock, fixed-income, and cash stakes, but used in combination with the fund's R-squared relative to the broader market, this can be a useful tool for finding funds that haven't hugged the index.
We included a few more criteria as well: To find funds with proven records, we also screened for funds with top-third 10-year rankings relative to their categories and, of course, managers who were responsible for those 10 years. As usual, we limited the list to funds with reasonable expense ratios that have minimum initial investments of $10,000 or less.
The screen returned the following funds as of June 17, 2008: Aegis Value American Funds Bond Fund of America American Funds Capital World Bond Chase Growth DFA One-Year Fixed-Income FBR Focus FPA New Income FPA Perennial Franklin Strategic Income Legg Mason Partners Aggressive Growth Longleaf Partners New Alternatives Oakmark International Oppenheimer Global Opportunities Oppenheimer Strategic Income Parnassus Royce Special Equity TCW Total Return Bond Vanguard Short-Term Investment Grade Weitz Partners Value Weitz Value Wells Fargo Advantage Asia Pacific Yacktman
This list has a diverse mix of Morningstar categories, so we'll highlight one fund from each of the broader equity and fixed-income categories. TCW Total Return Bond
This is one of our Analyst Picks in the intermediate-term bond category. It's run by Jeffrey Gundlach, Morningstar's Fixed-Income Manager of the Year in 2006. He has positioned it to compete with both core bond and corporate bond funds by keeping the fund's duration (a gauge of interest-rate sensitivity) between the (shorter) Lehman Brothers Mortgage Backed Securities Index and the Lehman Brothers Aggregate Bond Index, which is the benchmark for most core bond funds. The fund also buys bonds that don't totally sync up with those in the broader market. For example, Gundlach leans heavily on mortgage-backed securities, including collateralized mortgage obligations, ARMs, and inverse floaters. As the credit crisis has sent investors scurrying away from these securities, Gundlach views this as a fantastic buying opportunity. Careful issue selection among these instruments has also helped the fund stay ahead of most intermediate-term bond peers so far this year. Yacktman
This large-value fund is an interesting one to highlight, as its best-fit index is the S&P 500. The portfolio holds around 30 names, and with over 20% of assets in small- and mid-cap names, it doesn't always move in step with the benchmark. Managers Donald Yacktman and Stephen Yacktman tend to favor consumer- and service-oriented stocks that have strong cash flows, little debt, and discounted stock prices. True, Coca-Cola
, and Microsoft
garner the top spots here as well as in the index, but small companies like food manufacturer Lancaster Colony
and used car lender AmeriCredit
also hold prominent spots. As for the managers' focus on steadier, repeat-consumer firms, these stocks helped the fund outshine most peers during the 2000-02 bear market, as well as during the more recent market downturn.
Morningstar.com Premium Members can run this screen themselves by clicking here
. Not a Premium Member? You can still run this screen by taking a free, 14-day Premium Membership trial
. (Note that the results may change as funds come in or drop out of the screen over time.)