Investing tip of the month from Morningstar Investment Research Center, by Bridget B. Hughes, CFA, Senior Fund Analyst
Mutual fund leader boards are always interesting.
Did you know that on Monday, May 5, 2008, ProFunds UltraSector Mobile Telecommunications WCPSX gained nearly 8%, topping all mutual funds? During the global market correction between the end of October and mid-March, when the MSCI All Country World Index lost more than 17%, ProFunds UltraShort Japan UKPIX gained 84.32%! And over the past year, CGM Focus' CGMFX high-conviction portfolio, helped by some astute short positions in Countrywide Financial CFC, Freddie Mac FRE, and Ambac Financial Group ABK, gained 70%, putting it in the mutual fund universe's second place for that peri od.
When you look at short-term leader boards, you generally find narrowly focused funds that take on a lot of risk. Those rankings can make for good chatter, but they're not always meaningful. And while short-term returns can sometimes help you understand funds' behavior, they tell you little about the long-term merits of a mutual fund.
So what about the long-term leaders' list? Surely, over the long term, the funds with the best strategies and managers should rise to the top. I took a look at how funds are currently stacking up based on 15-year returns. There are more than 1,800 funds that are old enough to fall in that grouping (though many others have been liquidated or merged into other funds).
Tailwinds Still Help
As it turns out, some niche funds have persisted. On the current 15-year leader list, natural-resources funds and Latin America choices are most prevalent. BlackRock Global Natural Resources SSGRX tops that list, with an 18.17% average annualized gain. True, we like that fund and recently made it a Fund Analyst Pick in the category because of its experienced management team; however, there's no question that energy stocks have been in favor for the past five years, giving the fund some recent tailwind. The same holds for Latin America funds.
Still, these good long-term results suggest that it's possible to enjoy long-term success with more-narrow funds. The key is to remember to use them in very small doses. In fact, we'd suggest you invest only what you can afford to lose, particularly if the timing of your cash-flow needs is uncertain. Consider that on the bottom of the 15-year performance list are a number of similarly specialized funds, most prominently from the Japan-stock category. (And that doesn't even show all the cruddy funds that closed down.) Stick with our Analyst Picks for these types of mutual funds and invest for the long haul. Considering they're typically volatile over shorter periods, I'd take a contrarian approach, buying them when they are down as opposed to after a big run. (That means no natural resources or Latin American funds for me now, thanks--maybe Vanguard Health Care VGHCX instead.)
A Level Head Is an Advantage, Too
What I found more interesting about the long-term leaders list, though, is that you really don't have to take a lot of risk to rise above the competition. In fact, of the diversified funds that proved superior (landing in the fund universe's top 50), the best ones tended to be generally conservative in their stock-picking and philosophy. Unlike with the specialty funds, you don't necessarily need to be a contrarian buying these. Following are some of those that made the list that we recommend. There's a lot more competition out there now than there was 15 years ago, but these strategies and management teams give us confidence in their futures.
Columbia Value & Restructuring UMBIX
15-year Return: 15.82%
This fund recently got a new parent--and a new name--but it's still a winner. We most like its manager, David Williams, for his candor, humility, and simple approach. He's proved a great judge of corporate managements going through restructuring, which has paid off for shareholders. From time to time, the fund's conviction and long-term mindset mean it can fall behind the pack--and it can suffer bouts of volatility--but Williams has shown a knack for avoiding value traps. There is some key-man risk here--Williams has already amassed a multidecade record, and though he works with a small team, he is a big contributor to the portfolio--but as long as Williams remains at the helm (at least), we're confident. We recently made the fund an Analyst Pick, and Williams was a runner up in 2007's Morningstar Manager of the Year deliber ations.
FPA Capital FPPTX
15-year Return: 14.88%
Bob Rodriguez, this Analyst Pick's manager, may be bold in this portfolio's construction--he recently publicly boycotted buying any stocks because he didn't like the credit worries and risks that pervaded the markets--but at the heart of his process is what seems an innate need to preserve capital (avoid losses). Over the years, that's meant he's held a lot of cash and bonds in the portfolio from time to time. A contrarian investor, Rodriguez can have the fund looking out of step with the market, but we trust his intuition and experience. In another sign of his individualism, Rodriguez hasn't reopened the fund, as many of his tenured value peers have recently; he just doesn't yet see attractive enough valuations. Still, it's a good fund to add to your watch list if you invest through a broker.
Mutual Discovery MDISX
15-year Return: 14.74%
Over the past 15 years, portfolio managers at Mutual Series have come and gone--and a couple have come back. But the disciplined value process that has made this fund a success remains intact. Mutual Series is careful about who it hires, and the newer analysts and portfolio managers all share the same passion for value investing, arbitrage opportunities, and distressed investing that has long defined the group. Discovery is led by Anne Gudefin, who has been with the firm since 2000, and Charles Lahr (2003). This fund has been helped by its ability to hang tough in harder times for stocks as well as its flexibility to invest around the world as its managers see fit. It has also been less volatile than its peers. The fund's Z shares are closed, we recommend the fund's A shares TEDIX for investors using a broker.
Harbor International Instl HAINX
15-year Return: 14.49%
The first purely international fund in the top 50 is run by one of our favorite managers, Hakan Castegren, who, along with his team of four experienced analysts, was also named Morningstar's International Manager of the Year for 2007--a title he won in 1996. Castegren is somewhat flexible in his approach--searching for stocks in both traditional value and growth sectors as well as buying in emerging markets--but his sensitivity to valuations and research intensity have kept risk in check. The fund's blue-chip flavor makes it a great core holding. The institutional shares require a $50,000 minimum, but the fund's investor shares HIINX ask only $2,500 and also boast a reasonable expense ratio.
American Funds Capital World Growth & Income CWGIX
15-year Return 14.42%
Consistency and reason come to mind when I think of this fund, and that's just the way American Funds would have it. While the fund's performance never tops its world-stock category charts, neither does it frequent the group's basement. In building the portfolio, the fund's nine portfolio managers, each of whom run a separate portion of the fund here, certainly value quality and growth, but they aren't willing to overpay for it--in fact, they tend to buy when other investors sell, serving as a contrarian investor. (That certainly helps, given the fund's and fund family's enormity.) And they're keen on dividends, which helps smooth returns.
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