Yes, it’s time for my annual “what to buy” report, and with the big rally in growth and macro uncertainty, this year is a little tricky.

When we roll up our stock analysts’ fair value estimates by market cap, we find large caps are 4% overvalued, mid-caps are fairly valued, and small caps are undervalued by 3%. Like all macroeconomic indicators, these fair value estimates are informative but still a long way from ironclad predictors of the market.

My basic view is to diversify beyond large growth, stay invested but cautious, and seek out funds with improving fundamentals in a wide variety of areas. I’ve recently written about diversifying beyond large growth and about funds cutting fees. I’ll circle back to those ideas but don’t want to spend too much space repeating them. So, my main themes will be to stay invested but cautious as well as fund upgrades.

Allocation Funds to Dial Down Risk

Allocation funds are a good way to lower risk in your portfolio while still enjoying some of the return potential of equities.

Let’s start with T. Rowe Price Global Allocation RPGAX, which has a Morningstar Medalist Rating of Gold. The dramatic outperformance of US equities driven by the likes of artificial intelligence superstar Nvidia NVDA means foreign equities are less pricey than US ones. This fund has a baseline of 60% in equities, 28% in fixed income, and 12% in alternatives that managers Charles Shriver and Toby Thompson adjust depending on opportunities and risks. They allocate to skilled managers who can deliver solid results.

I’m also a fan of Steve Romick and FPA Crescent FPACX, which is run with a heavy emphasis on value stocks and cash. The approach emphasizes downside protection, and it won’t take unneeded risks just to keep up with peers or benchmark in the short run.

Vanguard Wellesley Income VWIAX is a bond-heavy portfolio that produces a decent level of income and pretty steady performance. That bond-heavy tilt moderates the upside, but if we’re taking risk off the table, that’s just what the doctor ordered. Wellington has a deep team of stock and bond analysts to find attractive securities with only modest downside.

For younger investors, a low-cost target-date fund is also a great choice, whether in your 401(k) or IRA.

Big Upgrades

Let’s look at some of 2024’s biggest rating upgrades. I limited the list to funds where fundamental improvements drove upgrades to one or more of the pillars of the Medalist Rating—People, Process, or Parent—and also led to an overall rating improvement.

Fidelity Floating Rate High Income FFRHX

We raised this fund’s Process rating to High, taking the overall rating to Gold from Silver in February. The People Pillar was already High. “Fidelity’s size and presence in the bank-loan market give this strategy a unique edge extending beyond the fundamental credit research that has long been the hallmark of this high-income research team,” writes Morningstar Analyst Max Curtin. “With a dedicated capital markets solutions advisor honing relationships with private equity sponsors, this group takes advantage of harder-to-source deals and favorable allocations compared with smaller players in the asset class.”

Vanguard Strategic Equity VSEQX

We raised the fund’s Process rating to Above Average based on some successful advances, and that boosted the overall rating to Gold.

“Portfolio manager Cesar Orosco took the helm here in February 2021 and patiently but firmly reshaped the approach here to pursue its historical philosophy,” writes Morningstar Senior Analyst Todd Trubey.

“The crucial change came in February 2023 when the team launched its machine-learning artificial intelligence engine. It runs parallel to the traditional quant model on the same six themes but adjusts dynamically and rapidly to changing market conditions. As it nears the two-year mark, it has performed according to plan in various environments, earning the Process rating upgrade to Above Average.

“Stellar returns since Orosco’s arrival and since the AI model went live suggest a sharp turn from subpar returns when he landed. From Feb. 27, 2021, through Nov. 30, 2024, Vanguard Strategic Equity gained an annualized 10.5%, trouncing the Russell Midcap Index’s 7.1% return and the typical mid-cap blend Morningstar Category peer’s 7.5% mark.”

Fidelity Capital and Income FAGIX

We boosted this fund to Silver from Bronze and its People Pillar to High from Above Average in July. “The combination of managers Mark Notkin and Brian Chang inspires confidence in the near- and long-term prospects of this strategy,” writes Curtin. “A proven veteran, Notkin joined Fidelity as a high-yield credit analyst in 1994. He began managing high-yield portfolios two years later and has now led this strategy with great success for over two decades. Comanager Chang has learned under Notkin’s guidance since rising to portfolio management from the high-yield research team in 2017; the firm officially named him to the portfolio in 2019.”

American Funds Mortgage MFAEX

In July, we raised this fund’s People rating to High from Above Average and the overall rating to Silver from Bronze. “Keeping tabs on the likely path of interest rates is key to this fund’s approach centered on agency mortgage-backed securities,” writes Morningstar Director Alec Lucas. “The managers’ views on interest rates along with the yield premiums of MBS over Treasuries inform their willingness to increase MBS exposure to around 90% of portfolio assets (as they did in 2024’s first quarter) or to drop to about 50% (as they did in late 2021).” The fund’s 0.62% expense ratio for its F1 share class is available in No Transaction Fee platforms.

FPA New Income FPNIX

This conservative bond fund earned a Process rating upgrade to High while maintaining Above Average ratings for the People and Parent Pillars, driving an overall upgrade to Silver. This is a fund you use to play defense rather than seeking maximum returns. “That style dovetails with the goals its managers have maintained for several years: gaining at least 100 basis points over the Consumer Price Index over five-year periods and positive returns over 12-month stretches, within a high-quality mandate,” writes Morningstar Director Eric Jacobson. “Given those parameters, they kept the fund’s duration short—even versus its short-term peers—beginning in early 2002. That metric stayed under 2.0 years through mid-2023. Its leaders have always had the flexibility to take duration longer but have said it would require major shifts in yields.”

Fidelity Growth Discovery FDSVX

We raised this fund’s rating to Silver from Bronze on the back of a Process upgrade to Above Average in April. The People Pillar was already Above Average. Managers Jason Weiner and Asher Anolic have executed this strategy well. “The managers seek companies poised to outperform thanks to solid, durable earnings growth,” writes Trubey. “The managers focus on quantitative metrics such as revenue growth and gross margins as well as qualitative traits such as competitive advantages. The upgrade to the Process rating comes because they are rigorous in their quant analysis and more thoughtful in their qualitative assessments, striving to match firms’ operations to mental models so they can assess not just that a company thrives but how it does so.”

JPMorgan International Focus IUAEX

This fund does a very difficult thing well: running a focused portfolio without excessive risk. We raised the fund’s Process rating to High and the overall rating to Silver. The fund “focuses on non-US firms that score well on balance-sheet strength, profitability, and management quality. Idea generation relies on this team’s global sector specialists, who scour the best ideas from J.P. Morgan’s vast regional equity research teams, which cover approximately 2,500 stocks around the world, by viewing their research with a global lens,” writes Morningstar Associate Director Andrew Daniels.

Oakmark International Small Cap OAKEX

This fund requires a ton of patience, but it can be rewarding. We raised its People rating to High, taking the overall rating to Gold. “While longtime manager David Herro remains listed here, he has delegated some responsibilities to Michael Manelli and Justin Hance, who have been working with increasing autonomy since becoming comanagers in 2011 and 2016, respectively,” writes Daniels. “Manelli and Hance have good credentials, but more importantly have proved to be savvy small/mid-cap investors under Herro’s mentorship. They consistently impress in interviews, are in sync with the team’s philosophy, and invest heavily in the offering.”

Vanguard Global ESG Select Stock VESGX

This Wellington-run fund has really impressed in its first five years. We raised our Process rating to Above Average and the overall rating to Silver. The “process is sensible and has been executed very well,” writes Morningstar Senior Analyst David Kathman. “The managers use quantitative screens to narrow down the investment universe before doing a fundamental deep dive on the most promising names, looking for global large-cap companies that combine positive environmental, social, and governance features with high and consistent returns on capital. They aim to keep the portfolio reasonably diversified by sector and region while maintaining a fairly concentrated portfolio of 35-45 stocks.”

AMG River Road Small Cap Value ARSVX

We raised this fund’s People rating to High and the overall rating to Silver in March. “Lead manager Justin Akin joined the firm in 2005 and has worked on this strategy since, first serving as an analyst and then as a comanager starting in March 2012,” writes Morningstar Analyst David Carey.

Diversifying Away From Large Growth

There are some good funds that have low correlations with the large-growth category that you might want to seek out if your large-growth weighting has grown to outsize proportions. I’m not suggesting you dump all your large-growth exposure.

Short-term bond funds like Vanguard Short-Term Federal VSGDX, Baird Short-Term Bond BSBIX, and Vanguard Short-Term Inflation-Protected Securities Index VTAPX move very differently from large-growth stocks. Municipal-bond funds like Fidelity Intermediate Municipal Income FLTMX are very dependable low-fee, high-quality funds.

In equities, small value is naturally the least like large growth. Royce Small-Cap Special Equity RYSEX is the sort of fund that I love as a diversifier. (I own this one in my 401(k).)

Good Funds Cutting Fees

Some funds have made meaningful fee cuts.

Silver-rated T. Rowe Price Tax-Free High Yield PRFHX cut fees by 4 basis points to 0.63%.

Bronze-rated TCW Core Fixed Income TGFNX trimmed its expense ratio by 7 basis points to 0.63%.

Conclusion

I’ve unearthed a wide array of attractive opportunities, but I wouldn’t want you to lose track of the big picture. You should be sure to stick to your long-term plan and not let a couple of appealing funds throw your asset allocation off-kilter. And if you need help with your retirement plan, might I suggest Christine Benz’s new book How to Retire?

This article first appeared in the January 2025 issue of Morningstar FundInvestor. Download a complimentary copy of FundInvestor by visiting this website.



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