Coming: ETF version of world's biggest mutual fund (AP)

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A Game-Changer for Mutual Funds (The Motley Fool)

By Amanda B. Kish, CFA Amanda B. Kish, Cfa – Tue Jun 14, 3:11 pm ET

Investors looking for the best mutual funds for their portfolios have typically had little direction in making those decisions. While the Morningstar star rating system has often ended up standing in as a recommendation service, it wasn't really designed to serve that purpose. Because the star system looks at past performance and risk-adjusted returns, star ratings are usually a better rear view mirror look at a fund, rather than a forward-looking dashboard view.

Now, though, things are changing. A new rating system on the horizon could have meaningful implications for the mutual fund world.

The next level
At their recent annual Investor Conference, Morningstar announced that it plans on adding new, more subjective analyst ratings to the wide universe of mutual funds. In contrast to the star ratings, the analyst ratings will be an attempt to judge how funds will perform in the future. Funds will receive a positive, neutral, or negative rating based on analyst expectations. Positive analyst ratings will be designated by AAA, AA, or A ratings, based on how relatively advantageous each fund is perceived to be. Morningstar expects roughly 10%-20% of all funds to earn some type of positive rating. Ultimately, the new analyst ratings are designed to be broader in scope and more responsive to potential changes at each fund.

While there's a lot of potential for things to go wrong in a rating system like this, an initial glance at the criteria Morningstar analysts will be using to rate the funds sets my mind at ease. There are five key areas that Morningstar believes predicts future performance. These include cost, investment process, past performance versus expectations, management skill, and company culture. These are all aspects of funds that investors should focus on anyways, so I'm glad to see these criteria being incorporated into a forward-looking measure.

While investors typically look to past performance as a primary screen when picking funds, I have long argued that performance is actually one of the last criteria that should be considered. It's more important to first find low-cost funds with long-tenured managers or management teams.

The next step is to home in on those funds with a consistent investment process and a long history of managing money in the same manner, rather than those that shift focus as the investing winds change direction. Only once you weed out the funds that don't meet all these criteria should you consider performance. Here, you want a fund that has a track record of solid performance in both good and bad market environments, not a one-trick pony. Since it looks like most of these measures will be incorporated into the analyst ratings in some way, I think Morningstar is on the right track here.

Due diligence still required
But while the new analyst ratings will likely go a long way toward helping folks narrow down the available universe of funds and hopefully make some good picks, investors shouldn't use these new ratings as an excuse to mentally check out of the fund selection process. These analyst ratings are absolutely no guarantee of future performance, and fund investors are still responsible for understanding how their chosen funds invest and what they own. In other words, don't think you can get away with just picking all AAA-rated funds and not give your portfolio a second thought.

I also think there is some potential for investors to buy inappropriate funds based on these new ratings. The analyst ratings may tell you which funds Morningstar thinks will do better than others, but that doesn't mean the fund is right for you. While a China-focused fund or a cloud computing tech fund may earn high marks, that doesn't mean that the average investor should own such an investment. There are lots of funds out there that post attractive returns and may be very well-run, but still aren't the best option for any particular individual.

And while the new rating system should help weed out some less attractive funds, it won't give investors any additional insight into the asset allocation process. In other words, how do those positive-rated funds fit into your overall portfolio? Investors will still need to start with an appropriate, well-planned asset allocation before even thinking about which funds they should be buying. If they don't get that step right, all the analyst ratings in the world probably won't be able to rescue their portfolio.

Ultimately, I think these new analyst ratings should be a good thing for fund investors -- if they are kept in context. More specifically, as long as investors don't come to rely on the ratings as their sole analytical tool, I think they could be a valuable part of one's fund selection process. Keep an eye out as Morningstar unveils these ratings beginning this fall. They could mark an important turning point for the mutual fund industry.

For more winning mutual fund recommendations and time-tested personal financial planning advice, check out the Fool's Rule Your Retirement service. You can start your free 30-day trial today.

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Ways to inflation-proof your mutual fund portfolio (AP)

By DAVE CARPENTER, AP Personal Finance Writer Dave Carpenter, Ap Personal Finance Writer – Thu Feb 24, 10:53 am ET

CHICAGO – Warnings of high inflation ahead have been around so long it's easy for investors to take them for granted.

Heavy government spending was supposed to have driven inflation sharply upward. Some experts predicted it would hit 8 percent by now.

So far, inflation is still tame.

However, the long era of low inflation likely is nearing an end. Prices have accelerated abroad due to super-heated economic growth in China, Brazil, India and other emerging markets. The U.S. consumer price index has risen by 0.4 percent in each of the last two months, too, increasing prospects that we will eventually have significantly higher inflation at home. Over the past year the index has risen 1.6 percent.

"Investors ignore inflation at their own peril," says Christine Benz, director of personal finance at Morningstar Inc.

Even those who normally leave their mutual funds on auto-pilot would be well-advised to consider inflation-proofing their portfolios.

Ways to protect yourself include overhauling your mix of funds, paring back on riskier international funds and adding offerings that focus on inflation-protected bonds such as Treasury Inflation-Protected Securities (TIPS) — a type of Treasury bond whose payout is adjusted every six months for inflation. Investing in commodities funds and dividend mutual funds also may help.

Benz discussed the options and best moves for individual investors in an interview with The Associated Press. Here are excerpts:

Q: Why can't investors rely on fund managers to mitigate the effects of inflation?

A: Not many managers spend a lot of time thinking about the macroeconomic environment, whether it's inflationary, deflationary, recessionary or whatever. Instead, most hew to a specific style (such as growth, value, small cap, large cap). For example, it's not typical for most core bond funds to buy TIPS. That means that investors who want to ensure that their portfolios have insulation against inflation should take steps to put it in place themselves.

Q: There aren't any mutual funds composed of I-bonds — inflation-linked government savings bonds — so isn't it better for inflation-wary investors to invest in TIPS?

A: Both TIPS and I-bonds are fine options.

I-bonds make good sense for investors' taxable accounts in that they won't owe federal income taxes from year to year — only when the bond matures or they sell. But with TIPS, investors are not limited to purchases of $10,000 per year as they are with I-bonds. By buying a TIPS fund you also get the advantage of professional management.

For plain-vanilla, low-cost possibilities, both the conventional mutual fund Vanguard Inflation-Protected Securities (VIPSX) and iShares Barclays TIPS Bond (TIP), an ETF, are solid. For an actively managed fund, investors might consider PIMCO Real Return (PRTNX) or Harbor Real Return (HARRX). For investors concerned that inflation is a global phenomenon, our analysts also like the exchange-traded fund SPDR DB International Government Inflation-Protected Bond (WIP).

Q: How effective are commodities in fighting inflation?

A: In theory, buying an investment that tracks commodities prices is a good way to hedge against inflation. As you're paying higher prices for food, gas, and other stuff you need, an investment in commodities should also be going up, helping offset those higher costs.

Unfortunately, the best way to obtain pure exposure to commodities is to take physical delivery of the stuff — whether it's pork bellies, cotton or oil — and that's simply not practical for mutual funds. Instead, most commodities funds obtain exposure by buying commodity index futures, which don't perfectly reflect commodity prices at any given point in time.

Q: With those shortcomings in mind, do you still recommend any particular commodities funds?

A: If investors are OK with that imprecision, they could look to an exchange-traded note like iPath DJ-UBS Commodity Index (DJP) or to actively managed commodity futures funds such as Harbor Commodity Real Return (HACMX) or PIMCO Commodity Real Return (PCRAX). (Traded on major exchanges, exchange-traded notes are a type of debt security that combines the aspects of bonds and ETFs.)

Q: Why should investors see dividend-stock funds as an inflation hedge as opposed to, say, bonds?

A: Stocks should be part of most investors' inflationary toolkits because their long-run potential to beat inflation is much greater than is the case for bonds, and certainly cash. And dividend-paying companies offer an important advantage that fixed-rate investments like bonds don't: If business is good, they can actually increase their dividends. Those higher payouts, in turn, can help offset higher prices.

Among our favorite dividend-growth funds are Vanguard Dividend Growth (VDIGX), a traditional actively managed mutual fund, and Vanguard Dividend Appreciation (VIG for the ETF and VDAIX for the traditional index mutual fund).

Q: Who should be thinking the most about adding inflation-fighting investments?

A: Retirees. Only a portion of the income that most retirees earn, such as their Social Security income, will automatically step up with inflation. The income they draw from their portfolios, by contrast, will be worth less and less as inflation increases.

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Ways to inflation-proof your mutual fund portfolio (AP)

By DAVE CARPENTER, AP Personal Finance Writer Dave Carpenter, Ap Personal Finance Writer – Thu Feb 24, 10:53 am ET

CHICAGO – Warnings of high inflation ahead have been around so long it's easy for investors to take them for granted.

Heavy government spending was supposed to have driven inflation sharply upward. Some experts predicted it would hit 8 percent by now.

So far, inflation is still tame.

However, the long era of low inflation likely is nearing an end. Prices have accelerated abroad due to super-heated economic growth in China, Brazil, India and other emerging markets. The U.S. consumer price index has risen by 0.4 percent in each of the last two months, too, increasing prospects that we will eventually have significantly higher inflation at home. Over the past year the index has risen 1.6 percent.

"Investors ignore inflation at their own peril," says Christine Benz, director of personal finance at Morningstar Inc.

Even those who normally leave their mutual funds on auto-pilot would be well-advised to consider inflation-proofing their portfolios.

Ways to protect yourself include overhauling your mix of funds, paring back on riskier international funds and adding offerings that focus on inflation-protected bonds such as Treasury Inflation-Protected Securities (TIPS) — a type of Treasury bond whose payout is adjusted every six months for inflation. Investing in commodities funds and dividend mutual funds also may help.

Benz discussed the options and best moves for individual investors in an interview with The Associated Press. Here are excerpts:

Q: Why can't investors rely on fund managers to mitigate the effects of inflation?

A: Not many managers spend a lot of time thinking about the macroeconomic environment, whether it's inflationary, deflationary, recessionary or whatever. Instead, most hew to a specific style (such as growth, value, small cap, large cap). For example, it's not typical for most core bond funds to buy TIPS. That means that investors who want to ensure that their portfolios have insulation against inflation should take steps to put it in place themselves.

Q: There aren't any mutual funds composed of I-bonds — inflation-linked government savings bonds — so isn't it better for inflation-wary investors to invest in TIPS?

A: Both TIPS and I-bonds are fine options.

I-bonds make good sense for investors' taxable accounts in that they won't owe federal income taxes from year to year — only when the bond matures or they sell. But with TIPS, investors are not limited to purchases of $10,000 per year as they are with I-bonds. By buying a TIPS fund you also get the advantage of professional management.

For plain-vanilla, low-cost possibilities, both the conventional mutual fund Vanguard Inflation-Protected Securities (VIPSX) and iShares Barclays TIPS Bond (TIP), an ETF, are solid. For an actively managed fund, investors might consider PIMCO Real Return (PRTNX) or Harbor Real Return (HARRX). For investors concerned that inflation is a global phenomenon, our analysts also like the exchange-traded fund SPDR DB International Government Inflation-Protected Bond (WIP).

Q: How effective are commodities in fighting inflation?

A: In theory, buying an investment that tracks commodities prices is a good way to hedge against inflation. As you're paying higher prices for food, gas, and other stuff you need, an investment in commodities should also be going up, helping offset those higher costs.

Unfortunately, the best way to obtain pure exposure to commodities is to take physical delivery of the stuff — whether it's pork bellies, cotton or oil — and that's simply not practical for mutual funds. Instead, most commodities funds obtain exposure by buying commodity index futures, which don't perfectly reflect commodity prices at any given point in time.

Q: With those shortcomings in mind, do you still recommend any particular commodities funds?

A: If investors are OK with that imprecision, they could look to an exchange-traded note like iPath DJ-UBS Commodity Index (DJP) or to actively managed commodity futures funds such as Harbor Commodity Real Return (HACMX) or PIMCO Commodity Real Return (PCRAX). (Traded on major exchanges, exchange-traded notes are a type of debt security that combines the aspects of bonds and ETFs.)

Q: Why should investors see dividend-stock funds as an inflation hedge as opposed to, say, bonds?

A: Stocks should be part of most investors' inflationary toolkits because their long-run potential to beat inflation is much greater than is the case for bonds, and certainly cash. And dividend-paying companies offer an important advantage that fixed-rate investments like bonds don't: If business is good, they can actually increase their dividends. Those higher payouts, in turn, can help offset higher prices.

Among our favorite dividend-growth funds are Vanguard Dividend Growth (VDIGX), a traditional actively managed mutual fund, and Vanguard Dividend Appreciation (VIG for the ETF and VDAIX for the traditional index mutual fund).

Q: Who should be thinking the most about adding inflation-fighting investments?

A: Retirees. Only a portion of the income that most retirees earn, such as their Social Security income, will automatically step up with inflation. The income they draw from their portfolios, by contrast, will be worth less and less as inflation increases.

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