Are These Funds' Glory Days Behind Them?

No-moat stocks have made a compelling case for themselves these past two years.

Morningstar’s No Moat Index has outpaced the S&P 500 as well as Morningstar’s Wide Moat and Narrow Moat Index by a wide margin.

But no investment style or strategy’s heyday lasts forever. According to this article by Morningstar fund analyst Ryan Leggio, Morningstar data indicate that any one investment trend could go in and out of style very quickly — with outperformance and underperformance frequently running in cycles of three or more years.

And given the signs of inflation that have been grabbing headlines as of late, our analysts suggest that moat-worthy firms will be more resilient in an inflationary environment than companies without a competitive advantage.

That doesn’t mean you need to completely scrub your portfolio of narrow and no-moat firms; they’ll still provide valuable diversification in certain environments, as Christine Benz points out in this video. But if you’re rebalancing your portfolio or otherwise making changes, less-moat-worthy firms and funds–particularly those that have recently enjoyed a very strong performance run–could be ripe for a pruning.

Subscribers to Morningstar.com’s Premium service can see moat ratings for their holdings on the quote and Analyst Report pages. To help home in on mutual funds with a big share of their portfolios in no-moat companies, we turned to our Premium Fund Screener.

In an effort to winnow down that group of offerings to those that have been riding the coattails of the no-moat rally, we screened on distinct portfolios of domestic stock funds with an average stock moat rating of none. (Morningstar assigns average moat ratings for mutual funds when at least 50% of a fund’s underlying stocks have moat ratings.) Premium members can replicate this screen by clicking here. The screener yielded 21 funds. We highlight two below.

Oberweis Emerging Growth (OBEGX)

After a 57% loss in 2008, this fund came roaring back with a 52% return in 2009. Still, its long-term record looks dismal as the fund has landed in the category’s basement for every trailing period of five years or more. Manager James W. Oberweis seeks companies with very high growth rates of 30% or more and aims to pay a reasonable price for them, seeking P/Es of less than half their growth rates.

But his penchant for small- and micro-cap stocks and some big-sector bets court a lot of risk. Indeed, the fund’s standard deviation is among the highest in its category during the five and 10-year periods. All in all, this fund’s risk-reward profile makes it a difficult fund to own.

Hennessy Focus 30 (HFTFX)

Beneath this fund’s impressive returns lurk some fundamental defects. For one, lead manager Neil Hennessy redefines active management by relying solely on quantitative metrics to determine stock picks. He takes the same set of quantitative metrics and reapplies them every fall to yield 30 new stocks for the portfolio.

Given that relatively hands-off approach, it’s hard to justify the fund’s steep 1.39% price tag. The fund also courts risk by making hefty bets in a few sectors, while providing virtually no exposure to others. On the whole, this fund does not paint a compelling picture for any investor.

This post originally appeared at Morningstar.

NOW WATCH: Money & Markets videos

Business Insider Emails & Alerts

Site highlights each day to your inbox.

Follow Business Insider Australia on Facebook, Twitter, LinkedIn, and Instagram.