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| | Mutual Funds
The best mutual funds you've never heard of
There are only a handful of consistently stellar mutual funds, and they're mostly unknown. Here's how they beat the market year after year.
By Timothy Middleton
Congress has been hearing from an unending procession of Wall Street experts who were shocked -- shocked -- when Enron (ENRNQ, news, msgs) went bust. They all say the same thing: We couldnt possibly have known the company was a hollow shell. So how did Val Jensen figure it out?
Jensen is lead manager of his namesake mutual fund, which trades under the ticker JENSX. It is a rara avis -- a large-capitalization growth fund that has managed double-digit annual gains in the recent bear market. Its average peer lost 5.7% for the same three-year period.
Whats different? Everybody on Wall Street says he reads annual reports, but Jensen actually does. Enron hasnt made any cash earnings for shareholders since 1994, says the manager, who focuses on money in the till rather than what creative accountants deem to be net income. Enron had to borrow money to declare a dividend! Jensen sneers.
Jensen is not exactly a household name. The funds assets are only $250 million. But it belongs to an extremely exclusive club with other funds that make money in bad markets as well as good ones. And they dont just get by -- they deliver consistent market-beating, double-digit gains. They dont take big risks and they almost never lose money.
There arent a lot of funds like that. Most are concentrated in the small- and mid-cap value camp, the only two groups to defy the bear market. We didnt want to look just there, however. We wanted to cover all the bases, from equity to balanced, small cap to large, growth to value, and foreign to domestic.
Successively winnowing lead us to eight funds that meet our goal of exceptional risk-adjusted performance across the entire investing spectrum. And although we cast a wide net, our "Elite Eight" have a lot in common. They are run by true contrarians who ignore momentum and faddish themes and focus instead on intrinsic value. There isnt a black-box computer geek among them.
Introducing the 'Elite Eight'
They buy at a discount, usually at least one-third below a stocks conservatively estimated inherent value. Then they hold on, usually for years, until the market confirms their judgment.
This old-fashioned approach seldom puts them on the front page; youve probably never heard of a majority of our picks. But no-name funds can be a blessing, says Diahann Lassus of Lassus Wherley & Associates in New Providence, N.J. We look for funds that the hot money is not chasing, she says.
Thats because hot-money funds tend to crash and burn: Think Janus, Van Wagoner and Oak Associates. And when hot money floods in and out, long-term shareholders take a bruising. Managers can get buried in cash when money floods in; long-term shareholders can get buried in taxes when it floods out.
| The Elite Eight | | Fund | Category | 3-yr return | 5-yr return | | Royce Low-Priced Stock (RYLPX) | Small value | 29.6% | 19.20% | | Needham Growth (NEEGX) | Mid growth | 28.1 | 22.4 | | Meridian Value (MVALX) | Mid blend | 27 | 24.2 | | First Eagle SoGen Overseas (SGOVX) | Foreign stock | 16.3 | 9.2 | | Dodge & Cox Stock (DODGX) | Large value | 15.9 | 14.8 | | Baron Growth (BGRFX) | Small growth | 15.2 | 14.3 | | Jensen (JENSX) | Large growth | 11.9 | 14.5 | | Thompson Plumb Balanced (THPBX) | Balanced | 10.5 | 13 |
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Notes: 3- and 5-year annualized returns as of Feb. 28, 2002.
Source: Morningstar
Just because funds arent the subject of cocktail conversation doesnt mean they cant furnish intoxicating results. These funds rank in the top 5% of their Morningstar categories, and they rank in the first or second tier of Lippers five-tiered Leaders ranking for consistency of performance and preservation of capital. They've delivered double-digit returns for the last three years, which includes the bear market, as well as the last five, which also captures the peak of the bull market.
These outstanding funds are also no riskier than the stock market; indeed, a majority are much less volatile. But despite their similarities, each is quite distinct from the others, with its own individual characteristics of risk and reward.
Royce Low-Priced Stock
Manager Whitney George runs this portfolio in the classic value style. We focus on companies and industries that are currently out of favor, like retailers a year ago and energy last fall, he says. We hold them until theyve had time to repair those short-term problems. Its very much a planting and harvesting process.
George demands a strong balance sheet, little or no debt, healthy cash flow and a history of high return on capital. He estimates what the company would be worth to a private purchaser, and wont buy if the stock price isnt at least one-third below that level.
The small-cap world in which Royce operates is notoriously risky, so the fund spreads its assets over about 165 names. The market over time will produce great returns, says George, and were trying to take some of the risk out and make it a little less bumpy.
A bellwether stock is Oakley (OO, news, msgs), the sunglass maker. Its price bumps around in the range of $5 to $25 a share because its earnings are anything but consistent. They are very passionate about what they do, says George. Theyve had a fight with Sunglass Hut, their largest customer, and sued Nike (NKE, news, msgs) over patent infringement. Its a core position in the fund. We use it when its down, and we lighten up when it goes up, George says.
Needham Growth
Theres nothing classic about Needhams approach to growth investing. Manager Peter Trapp shops for high-growth companies, but only at bargain prices -- a price-to-earnings ratio less than half the companys long-term growth rate.
Trapp also puts as much as 25% of the funds assets into short sales, which are a bet their price will decline. He is also willing to hold a lot of cash if he cant find attractive investments. These attributes set him apart from most of his peers, and Needham is the only one of our Elite Eight that doesnt rank as a Lipper Leader.
But these are also the attributes of a careful stock picker, rather than a crowd follower, and it has paid off. Needham shot up nearly 80% in 1999 but, notes Morningstar analyst William Harding, its showing since then is even more impressive. While other mid-cap growth funds were slaughtered in the bear market, Needham went up 7.4% in 2000 and 12.2% last year.
Meridian Value
This remarkable fund is no longer unknown: Investors discovered it one year ago, and since then its assets have surged to $1.22 billion from $285 million. But its record hasnt suffered. In the 12 months ended Feb. 28, it beat the S&P Mid-Cap 400 Index by nearly 3 percentage points.
Lead manager Kevin OBoyle looks for beaten-down names and a catalyst that will end their woes and send their stock higher. Early last year he bought Office Depot (ODP, news, msgs), in time to catch its recovery. Later in the year, he bulked up on distressed telecommunications stocks.
Morningstar analyst Christopher Davis notes that the influx of assets has forced OBoyle to buy bigger companies, pulling the fund into the mid-cap range from its former focus strictly on small caps. But its average market cap is less than $3 billion, so it hasnt strayed far. We see no reason why this offering shouldnt continue to receive our endorsement, Davis says.
First Eagle SoGen Overseas
We had to make a slight exception with this fund to include it among the others -- its five-year annualized returns are just below double digits. But thats still striking, considering the average foreign stock did one-tenth as well.
Lead manager Jean-Marie Eveillard is an incredibly patient investor; turnover in the fund is less than 20%. His former employers were not: The SoGen in the funds name comes from Societe Generale, the French financial services firm that sold its interest in January 2000, immediately before Eveillards deep value approach began to beat MSCIs EAFE Index by 20 percentage points and more.
SoGen didnt love me anymore, Eveillard chuckles. He has had the last laugh; in 2001, only one foreign-stock fund with at least a five-year record beat his performance, and that rival, Oakmark International Small Cap I (OAKEX), is nearly twice as risky as Eveillards fund.
Dodge & Cox Stock
By far the largest of our eight funds, with assets of nearly $10 billion, this one exhausts anybodys list of superlatives. Since it was launched in 1965, it has delivered annualized returns of more than 12%. It has always ranked in the top 2% or 3% of funds of its type. It lost money in one of the last 20 years, 1990.
The fund takes only about two-thirds as much risk as the S&P 500 but has beaten it by an average of more than 2 percentage points in each of the last 15 years. Its expense ratio is a minuscule 0.54%, about one-third the equity average. Turnover is a scanty 32%. By most valuation measures, it pays about half the market price for its purchases.
The team-managed funds style is to buy market-leading companies with strong growth records when they are out of favor. Early last year, for example, it took an 8% position in technology stocks. By year-end they had appreciated nearly 50%. But it also made money on Old Economy companies such as FedEx (FDX, news, msgs) and Whirlpool (WHR, news, msgs).
Baron Growth
The small-growth category is the most volatile of the major asset classes, and finding one that fit all our criteria was impossible. This fund came very close, however, consistently ranking in the top performance quartile of its group with below-average risk.
Also, although its beaten the market in each of the last three years, Baron fell 4.6% in 2000. That was such a disastrous year for small growth stocks, however -- the Russell 2000 Growth Index ($RUO.X) tumbled 22.4% that year -- that Barons relative performance was outstanding. Since inception in 1994, the funds annualized returns have been 21.8%.
Standard & Poors has chosen the fund to represent the small-growth category in its Model Select Funds Portfolios. S&P says it was chosen because it ranked highest among its peers in terms of consistency of performance, style purity and superior management.
Manager Ron Baron is known for buying attractive companies at a 50% discount to their worth and holding them until the market falls into line behind him. He shunned the tech bubble and, last September, was a buyer of hotel stocks as they plunged. Turnover is low and nearly half the funds assets are concentrated in the top 10 names.
Jensen
As if avoiding Enron werent enough, Val Jensen also sold General Electric (GE, news, msgs) before Pimco bond boss Bill Gross called its accounting into question last month. Its stock price exceeded his estimate of the companys intrinsic value.
Jensen wont consider a stock that hasnt demonstrated a 15% return on equity for 10 consecutive years. Those 110 or so names are the worlds best companies, with a demonstrated sustainable competitive advantage over their rivals.
He then models the companys growth rate and estimates the cash flow this growth will produce over the next 10 years. (After 10 years he assumes growth will revert to the market average.) The present value of those earnings leads to an estimate of a companys intrinsic worth.
Jensen buys the 25 or so stocks with the biggest discounts to intrinsic value and focuses 60% of assets in the 10 he thinks are best. Even in a bear market, these demonstrated leaders tend to hold up. If they dont, or if they become overvalued, Jensen sells. He sold Intel (INTC, news, msgs) two years ago, at the peak of the tech bubble, when it was trading well in excess of its intrinsic value, he says.
Thompson Plumb Balanced
This fund edged out T. Rowe Price Capital Appreciation in the balanced category because the latter fund had a manager change last year and the new managers are operating somewhat differently.
Utterly unknown to most investors -- after 15 years of exceptional performance, the fund has assets of only $105 million -- Thompson Plumb Balanced combines a value-tilted equity portfolio with high-quality bonds. Currently bonds and cash are 33% of assets, with the balance in stocks.
When we purchase a stock, were anticipating that over the next few years unfolding events will allow a company to enjoy an expansion of its perceived intrinsic value, says Thomas Plumb, manager of the Madison, Wis., fund. When the Fen-Phen debacle decimated shares of American Home Products in the mid 1990s, for example, Plumb was a buyer. He has held on -- the company now is known as Wyeth (WYE, news, msgs) -- because he thinks drug stocks as a whole are underappreciated.
As the bear market so vividly demonstrated, preserving investment gains can be harder than earning them in the first place. Anybody who doubled their money in technology funds in 1999 likely lost all those gains, and more, in 2000 and 2001. Investors in these funds not only didnt lose money -- they made it.
What they're buying now
Easy Street: If you read the fine print on your 401(k) statement, you might discover your plans custodian is State Street (STT, news, msgs), the worlds largest vault for institutional investors, mutual funds and pension plans. Jensen believes it would cost far more than twice the companys current market cap of $18 billion to create such a behemoth, and therefore that $100 a share -- twice the current price -- is a fair value.
Slick potential: Input/Output (IO, news, msgs) makes seismic equipment for the Oil Patch and is a favorite of Royces George. Its price has fallen to less than $10 from $30 in late 1997, because it has endured declining sales and minuscule profits. Now, however, Theyre working on a new technology that could have a very dramatic impact on how we discover oil, George asserts. In the right environment, this is a stock people could get very excited about.
At the time of publication, Timothy Middleton didnt own any of the securities mentioned in this article.
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