Morningstar recently issued a new Stewardship Grade for the Wells Fargo Advantage funds. The firm's overall grade--which considers corporate culture, fund board quality, fund manager incentives, fees, and regulatory history--is a C. What follows is Morningstar's analysis of the firm's corporate culture. This text, as well as analytical text on the other four Stewardship Grade criteria, is available to those who subscribe to Morningstar's software for advisors and institutions: Morningstar Principia®, Morningstar Advisor Workstation(SM), Morningstar Office(SM), and Morningstar Direct(SM).
Wells Fargo Advantage has grown into one of the nation's largest fund families, thanks in large part to a string of acquisitions and a handful of particularly successful funds. It has done a decent job caring for fundholders' capital. Many of its steward practices have improved over the past decade. There's room for improvement in some areas, like the fund managers' investment in the funds they run, but overall, this firm's stewardship profile fits the industry standard.
As the fund family's name suggests, this asset-management firm is owned and operated by one of the largest U.S. banks, Wells Fargo (WFC). As such, mortgage lending and deposit gathering are Wells' primary businesses--not money management. As is the case with its giant branch banking network, Wells Fargo's fund management business has grown primarily by acquisition over the years. Some of the deals were specifically with asset management in mind. This was the case in 2005, when Wells purchased the Strong Funds, a midsize Midwestern asset manager, on the heels of a regulatory mishap at that firm. The SEC found that Strong's founder was disclosing its fund holdings to a select hedge fund before those positions were made public.
Other bank-led deals have had even larger impacts on Wells' money-management arm, including the 2009 merger with Wachovia. The Wachovia acquisition doubled Wells' fund lineup, saddling the surviving firm with Wachovia's Evergreen funds, a diverse fund lineup. A few months after the Wachovia deal closed, the SEC found that an ultra-short-term Evergreen bond fund mishandled its securities pricing in 2007 and 2008 and then selectively disclosed the incident to fundholders. Since the Wachovia union, Wells has done a good job sorting through its broad lineup, merging away more than two dozen redundant funds, lowering expense ratios for many fund shareholders, and beefing up its compliance effort.
Selling Beyond the Bank
Wells Fargo Advantage also has broadened its funds' distribution. In the late 1990s and early 2000s, more than 80% of the firm's fund assets were gathered via internal distributors, and the firm employed only a dozen fund salespeople. As of year-end 2012, two thirds of sales stemmed from major broker/dealer platforms, and the firm employs 137 fund salespeople. The attention to asset growth has boosted Wells Fargo Advantage's mutual fund assets under management to $214 billion as of Dec. 31, 2012. It is the second-largest bank-owned fund family, behind JPMorgan.
Within the mutual funds, about a third of the firm's assets are in U.S. equity funds and a fourth is in municipal-bond funds. Balanced and taxable-bond funds represent another third of the firm's fund assets, while non-U.S.-focused funds are the smallest piece of the pie at about 5% of fund assets.
Wells Fargo Advantage continues to embrace a multiboutique structure, where investment teams--many of which are separated geographically--work autonomously. A multiboutique structure can be advantageous because established teams of money managers can employ proven investment strategies without unnecessary interference or distraction from the parent company. The same structure can present challenges, too. For example, some teams may have better resources than others or pursue decidedly different investment philosophies. And, often, some teams produce better relative returns than others.
Uncovering the Gems
Wells Fargo Advantage has some teams that have done particularly well. A handful of funds have garnered significant assets on the heels of good performance, including Wells Fargo Advantage Growth (SGROX), a $10.7 billion large-cap growth fund that has earned a Morningstar Analyst Rating of Bronze, and a few municipal-bond offerings run by Lyle Fitterer, including Silver-rated Wells Fargo Advantage Short-Term Muni Bond (STSMX) and Bronze-rated Wells Fargo Advantage Municipal Bond (SXFIX). Wells Fargo's target-date funds--the Wells Fargo Advantage Dow Jones Target series--also have put up good performance, in large part due to the series' asset allocation, which dedicates relatively few assets to stocks in the years leading up to and in retirement. Given that more-cautious stance, it has resonated well with retirement-savers in the wake of 2008's market crisis, and assets have grown to more than $13.8 billion as of Dec. 31, 2012.
Wells Fargo Advantage has done a good job hanging on to its fund managers. Firmwide, the five-year manager-retention rate is 92%, indicating that, overall, the management ranks have been stable. Several key managers from the former Evergreen organization have stuck around since the 2008 merger, including Margie Patel, the well-known fixed-income skipper. On average, a Wells Fargo Advantage fund's most-experienced manager has been at the fund's helm for nearly nine years.
While this firm has no major flaws in its stewardship profile, its execution has been far from flawless. Morningstar analysts have expressed concerns about the strategies behind Special Small Cap Value (poor sell discipline) and Ultra Short Term Income (too risky). Even Asset Allocation, one of the firm's largest funds and subadvised by institutional powerhouse GMO, has shortcomings, particularly around its expenses, that prevent it from earning a Morningstar Analyst Rating of Gold, Silver, or Bronze, which would signal Morningstar's conviction in the fund's ability to outperform its typical peer on a risk-adjusted basis.
The firm's expense ratio structure also is inconsistent. The funds' Investor shares, many of which are the funds' oldest share classes, tend to be pricey relative to other no-load category peers. Wells Fargo isn't competing on price in these direct-sold shares because it intends to gather assets through its share classes targeted at advisors and institutions, many of which sport relatively lower expense ratios and collectively represent more than 80% of the firm's fund assets. This pricing strategy does not represent an industry best-practice. Top stewards of capital price all of their share classes reasonably.
It also remains to be seen whether Wells Fargo Advantage can demonstrate it's a top-drawer asset manager and steward while under the ownership of a bank. Such ownership arrangements can prove challenging because events well beyond the firm's asset-management business can have a significant impact. For example, it took Wells Fargo Advantage 19 months to reconcile its fund lineup after the sudden Wachovia marriage. That’s not an unreasonable time period given the scope and suddenness of a merger prompted by a global financial crisis. The funds' parent company arguably had bigger challenges to address first. But stand-alone asset managers of a similar size arguably have fewer outside business pressures.
The Wells Fargo Advantage/Evergreen merger has taken its toll on Wells Fargo Advantage's Morningstar Success Ratios, which measure the share classes at the beginning of a period and compare them with the number of share classes that outperformed the category average in the ensuing years. Firms that drastically shrink their fund lineups have fewer share classes eligible for the numerator of this equation, holding down their success ratios. That's been the case for Wells Fargo Advantage: Its five-year Morningstar Success Ratio was 38% and its 10-year figure was 31% on Jan. 31, 2013. Those ratios are even lower when considering risk-adjusted returns.
To be sure, many of Wells Fargo Advantage's recent moves have been in fundholders' best interests, and as a whole, the stewardship practices here are stronger than in years past, but some notable shortfalls remain.
Laura Pavlenko Lutton does not own shares in any of the securities mentioned above.