While most investors favor mutual funds with four-or five-star ratings, there may be hidden gems in some of the lower-rated funds.
That's because a low rating doesn't necessarily mean it's a bad investment.
Morningstar assigns star ratings to funds across multiple investment-style categories based on risk-adjusted returns over three-, five- and ten-year time periods.
Morningstar analyst Jonathan Rahbar explains that funds tend to fall into the two-star camp due to above-average risk, an investment style that goes out of favor or a management change.
“Just because a fund’s been underperforming doesn’t mean it’s not worth owning,’’ says Alex Urbani, of the Chicago investment advisory firm Main Street Advisors.
Urbani started using the Pimco Commodity Real Return Strategy Fund in January 2006 when it was a 1-star rated fund competing against funds with a more narrow focus on oil or gold. Today the fund carries a four-star rating in a more appropriate category of diversified commodity funds.
To identify some laggard portfolios, CNBC.com combed Morningstar’s fund database across four broad categories—large cap, mid cap, small cap and international equity—for two-star funds with no sales loads, low investment minimums and management in place at least five years.Page 1 of 6 | Next Page