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A great fund you shouldnt own
The long-run track records of Brandywine's funds are very, very good. It's the short-run volatility that can drive an investor crazy.
By Timothy Middleton
Bringing the Brandywine funds to your attention is dangerous, I know. The odds are that a hefty minority of their shareholders have lost money on them. I wouldn't invest in them myself.
But these are outstanding funds for the right kind of investor. And, by defying almost every tenet of conventional investment wisdom, they are instructive, as well.
The flagship Brandywine Fund (BRWIX) gets a mediocre three-star rating from Morningstar Inc. and it has ranked among the top 25% of mutual funds in only three of the last 10 years.
Despite all of this, Morningstar analyst Karen Paplois gives the fund a glowing write-up, concluding: "Patience has paid off for long-term shareholders. ... The fund's long-term record is strong."
Indeed it is. The fund, which invests in companies of every size, has delivered returns averaging 13.5% over the last 20 years. Its 14-year-old sibling, Brandywine Blue (BLUEX), which sticks to big-cap stocks, has averaged 13.9% in that period. Their younger brother, Brandywine Advisors (BWAFX), a mid-cap portfolio, is not yet five, but it's beaten the market by more than a full percentage point in each of the last three years.
Brandywine is also one of the most ethical fund companies in the marketplace, and its funds are very intelligently managed by Friess Associates.
But their performance is wildly -- and I mean wildly -- inconsistent. When they go on a tear, which they're doing now, they attract a flood of assets. Then they fall into the market's basement, and those droves of performance-chasers flee -- but not before a wad of their cash has disappeared.
So you can learn a lot from these funds, whether you invest in them or not.
If you really are a long-term investor -- for retirement, say -- and you can steel yourself to treat reverses as mere paper losses, you can expect above-market returns. The best investors, including Warren Buffett, are often very unpopular, as he was in the late 1990s. But if they stick to their craft -- which Buffett does, and which Brandywine's manager does, as well -- you can keep faith they'll make it all back, and then some.
If you choose not to invest, it will be because you've looked beyond superficial things like star ratings and short-term performance to the core of a fund decision, which turns on how this fund and this manager fit into your portfolio, which also means your comfort zone.
I know from experience that I can't suffer year after year of poor performance. Oh, me of little faith! But that's me. Brandywine Blue is a five-star fund at the moment, and I'm drawn to top-ranked funds. But not this one. Much as I admire real mavericks, I am not one myself. Are you?
Beating, not tracking, the market
Brandywine is perfectly consistent in its investment approach, which is to buy top-flight growth stocks at a discount and then sell them at a profit when a catalyst like a new product or an improved marketplace causes other investors to take notice of them.
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It's a simple and elegant idea, and it works -- but only over very long periods. The reason is that 70% of the time or so, Wall Street is taking a totally random walk to nowhere, and good fundamentals and $1.60 will buy you a cup of coffee.
But these managers don't abandon their senses just because the market has.
"The periods when were out of step with the broader market tend to be marked by speculation, macro concerns or some other force that drives a disconnect between fundamentals and share prices," says William D'Alonzo, chairman of Brandywine Funds and lead manager of all of its portfolios.
Right now those negatives are absent enough that all three Brandywine funds are completely in sync with the market. Brandywine Advisors ranked among the top 3% of funds of its type in the first six months of this year, and the other two in the top 11%.
They're flying high partly because D'Alonzo and his staff of more than 20 research analysts were early to spot the rally in energy and basic materials. The flagship fund began the year with more than 40% of assets in these two sectors.
These are not classic growth areas, which is one reason why growth funds overall are doing so poorly now. Brandywine has always gone its own way, however. The flagship has an R-squared, or correlation to the S&P 500, of only 51. How uncorrelated is that? Brandywine tracks the big index about as closely as the Smith Barney Municipal Bond Funds National Portfolio (SBBNX) does, which is to say not too closely.
Holdings that grow -- or else
Brandywine rolls the dice on a large number of prospects, 100 or so, that already enjoy some favor on Wall Street. The difference is that the company believes these stocks will do better than other analysts expect.
"We isolate rapidly growing companies -- typically 20% or more in year-over-year earnings growth -- that boast catalysts, such as a new product, management team or market opportunity likely to drive earnings in excess of consensus expectations," D'Alonzo says.
Thus it will pay up for a stock -- as much as 25% above the average market price/earnings ratio -- but it will pay much less than most growth managers; an average of 15% less. Brandywine establishes fair values for stocks before it buys them, and, when they hit that number, it sells, often to other, less-quick growth managers.
In the second quarter, Brandywine Fund scored a gain of more than 40% in Corning (GLW, news, msgs) as earnings doubled amid the clamor for flat-panel TV and computer screens. Its stake in Southwestern Energy (SWN, news, msgs) leaped more than 60% as both earnings and new-well production were better than expected.
"We dont ride out rough patches, either," says D'Alonzo. Brandywine is quick to dump stocks that have succeeded and even quicker to throw out those that haven't work out. Turnover averages 250% or more. In the second quarter, it completely eliminated huge positions in Companhia Vale do Rio Doce (RIO, news, msgs), the big Brazilian supplier of iron ore to the steel industry, as worldwide demand for steel waned, and in Yellow Roadway (YELL, news, msgs) as transportation demand appeared to stall.
All the right ethical moves
In this era of financial scandals, Brandywine is refreshing because it puts a premium on corporate governance at the companies it buys, as well as on itself.
Among other things, it retains two accountants as consultants to delve deeply into the financial statements of companies the funds are researching. D'Alonzo says he never owned Enron Corp., for example, because his accountants "couldn't get their hands around" the company's books. Nobody could -- they were fraudulent -- but legions of mutual funds didn't even try.
The funds also eschew sin stocks, such as gambling and liquor. Founder Foster Friess is a born-again Christian, and many of the firm's private clients are religious organizations. In all, Friess Associates manages about $9.6 billion.
D'Alonzo says employees of Friess Associates are the largest shareholders of the funds, with $150 million of personal assets invested. Brandywine Funds are the only equity choices in the company 401(k) plan. Directors are paid in fund shares rather than cash.
Friess Associates is 70% owned by Affiliated Managers Group (AMG, news, msgs). The rest is owned by Friess employees.
Brandywine's story would be idyllic, except for the dizzying streakiness of the funds' performance. Here is how the Blue fund compares with its rivals over the last decade. (Lower is better).
| Brandywine Blue vs. other large-cap growth funds | | Year | Brandywine's percentile ranking | | 2005 YTD | 11 | | 2004 | 1 | | 2003 | 40 | | 2002 | 3 | | 2001 | 61 | | 2000 | 4 | | 1999 | 23 | | 1998 | 99 | | 1997 | 83 | | 1996 | 22 |
|
Note: YTD as of 6/30/2005. Best=1; worst=100.
Source: Morningstar Inc.
Whew! Last year, the fund was at the absolute peak of performance, having ranked in the top 1 percentile of its category. The nadir, in 1998, saw it at the bottom of the same heap. When the performance is smoothed, it looks much better: a percentile rank of 1 for the last year, 7 for three years, 5 for five years and 16 for 10 years.
But only the most trusting and patient investor can have confidence that one year's poor results will be smoothed out by gains in the next. In 1998, when it did so poorly, assets shriveled 40%, to $356.8 million. Last year it sparkled, and this year assets have ballooned 40%, to $923.4 million at the end of June.
So it's clear that about 40% of the fund's shareholders during peak periods have bought too late to share in the gains. And then they sell at the bottom, losing their shirts. Can you resist making the same mistake?
I could not, so I've never owned any of these funds, and I probably never will. And I can't imagine that anybody would want to own more than one of them, since they are so similar and, indeed, the portfolio of the flagship fund heavily overlaps Blue in the big-company range and Advisors among mid caps.
But if the roller coaster is your favorite ride and you don't mind the $10,000 minimum purchase requirement, these are great funds to ride it in. You can trust them, and you can't say that about most mutual funds.
At the time of publication, Timothy Middleton didn't own any securities mentioned in this article.
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