Bruce Berkowitz > spends his days like a lot of other fund managers: reading economic reports, chatting about investment ideas with his chief research officer and meeting with companies he's thinking of adding to the portfolio. But his ho-hum routine is producing something many managers can't seem to match these days he beats Standard & Poor's 500-stock index almost every year, in good markets and bad. Over the past decade, Berkowitz's $17 billion Fairholme Fund has returned about 12 percent a year, on average, at a time when the index has been essentially flat. "He's the one value-fund manager who comes closest to Warren Buffett," says Michael Breen, associate director of fund research at Morningstar.
Too bad more managers aren't in the same league. Mutual funds have been under attack lately, and for good reason. More than a quarter of actively managed stock funds trailed the indexes they're measured against by five percentage points or more in the first nine months of 2010, according to a study by J.P. Morgan. That was the worst performance since 1998, and it helps explain why investors have been stashing their money in alternatives like bond funds and exchange-traded funds. The flip side is even scarier: Just 7 percent of actively managed funds were beating their benchmarks by five percentage points or more. Why the underperformance? Analysts point out that most active managers who handpick stocks instead of mimicking a market index need to beat the market by at least two percentage points a year to cover their management fees and trading costs. The uncertain economy also led many managers to hold plenty of cash in 2010 a strategy that backfired when the market marched higher. It was "an awful year for active managers," concludes Thomas J. Lee, a J.P. Morgan analyst who authored the study on how active managers are falling behind.
How do you find the ones who seem to come out ahead no matter how difficult the market or the economy? One answer, it seems, is that experience matters. While it's tough to match the tenure or the investment record of Warren Buffett, the managers who have beaten their indexes by wide margins tend to be seasoned pros who have stuck to their investment strategies year in and year out. The managers of this year's winning funds have been at the helm 50 percent longer than the average fund manager. And that gives them the confidence to make some bold bets, whether it's owning fallen financial giants like American International Group (AIG)
Each year, SmartMoney whittles the list of 6,800 mutual funds available in the U.S. to a handful of standouts. To find the top funds in four categories, we start by taking the managers' experience into account and throw out funds with sky-high expenses. Using Morningstar data, we picked funds that outperformed their peers in the roller-coaster market of the past five years. Some investors have taken note: Two winners, Fairholme and Thornburg International Value, each raked in more than $3 billion in the first nine months of 2010 not bad at a time when investors yanked tens of billions out of all equity funds.
Foreign Stock Funds
Santa Fe, N.M., doesn't fit the classic Hollywood image of an international financial hub. There are more cacti than stock traders, and no one would mistake the corner bank for a giant of world commerce. Yet CEOs from headquarters as far-flung as Saskatoon, Saskatchewan, and S o Jos dos Campos, Brazil, touch down in this desert oasis to meet with the portfolio managers of the Thornburg International Value fund. Perhaps it's "the magic of Santa Fe," jokes William Fries, one of the fund's three managers. Or perhaps he's just being modest. The 71-year-old money manager has the fund world's equivalent of a perfect game: He has beaten his benchmark every year since the fund's inception in 1998.
As more investors discover the fund, Fries and his comanagers get a steady flow of new money to buy stocks. That's something mutual fund managers can no longer take for granted and it helps explain the rush of sunscreen-toting CEOs heading toward Fries and his team. For years Fries managed the fund alone. Today he shares the stock picking with comanagers Wendy Trevisani and Lei Wang. "We all have to agree," says Fries, "or we won't buy a stock."
While some managers stick to a specific type of investing, Fries is more flexible, despite the value in the fund's name. "Growth is not a dirty word," he says. Nor are the managers afraid to kick the tires. Before adding Volkswagen to their portfolio last year, they talked to a Volkswagen dealer on Long Island about the dealer's perspective on the business. While Fries is optimistic about VW's prospects in the U.S., he's also excited about its position in China. In all, emerging markets often make up about 20 percent of Thornburg International nearly twice as much as the amount that's in other broad-based foreign stock funds, says William Samuel Rocco, a Morningstar fund analyst.
The group has had its share of misses. The National Bank of Greece was one of its best performers in 2009, but the shares took a dive last year, when investors started worrying about Greece's debt burden. The bank's management team even made the pilgrimage to Santa Fe, but it didn't help: The Thornburg managers still decided to sell the stock. Says Fries, "We want every stock to count."
Thornburg International Value
Managers: William Fries, Wendy Trevisani and Lei Wang
Assets: $24 billion
Expenses: $133 per $10,000 invested
5-Year Average Annual Return: 6.4%
Manager: Brent Lynn
Assets: $13.7 billion
Expenses: $87 per $10,000 invested
5-Year Average Annual Return: 13.8%
Comment: The longtime fund manager isn't afraid of stocks from emerging markets, and that can lead to volatility. But like Thornburg International, the fund boasts a strong 10-year average annual return of around 8 percent.
Masters' Select International
Managers: David Herro, Ted Tyson, William Fries, Jim Gendelman, Amit Wadhwaney and others
Assets: $1.5 billion
Expenses: $115 per $10,000 invested
5-Year Average Annual Return: 5.0%
Comment: A taster's choice sampler with the portfolio divided between several star fund managers, including our foreign-stock-fund winner.
U.S. Large-Cap Funds
It's easy to mistake Bruce Berkowitz for a hedge fund manager. Unlike many traditional mutual fund managers, he'll buy the debt of ailing companies or participate in initial public stock offerings. He limits the fund to around two dozen holdings, so a single position can have a huge impact on portfolio performance. And because he builds big stakes in those holdings, Berkowitz often has influence over many of the companies in his portfolio. "We try to treat our investments as if we were silent partners in the business," he says.
In the wake of the financial crisis, Berkowitz scooped up heavily discounted financial stocks. Some have paid off big: Shares of municipal-bond insurer MBIA (MBI)
Berkowitz hasn't done as well with St. Joe, a Florida real estate developer that owns hundreds of thousands of acres of raw land. The fund began purchasing shares around $32 about three years ago; they recently traded below $20. Miami-based Fairholme owns 30 percent of St. Joe, and Berkowitz likes its long-term prospects, calling it a "storied" company with "beautiful land."
While Fairholme's aggressive nature might give risk-averse investors heartburn, the fund which shares the top spot this year with the Yacktman fund has a track record that's hard to ignore. Double-digit average annual returns over the past decade sent the fund's assets soaring to $17 billion, up from just $17 million 10 years ago. At the same time, one thing the onslaught of new money hasn't done is lead Berkowitz to increase the number of holdings. "What's the point of buying my thirtieth best idea when I can buy more of my best idea?" he says.
Manager: Bruce Berkowitz
Assets: $17.0 billion
Expenses: $100 per $10,000 invested
5-Year Average Annual Return: 8.2%
Managers: Don and Stephen Yacktman
Assets: $3.1 billion
Expenses: $93 per $10,000 invested
5-Year Average Annual Return: 8.9%
Comment: A father-and-son team runs this large-cap fund, focusing on battered stocks with solid long-term business prospects.
Nuveen Tradewinds Value Opportunities
Manager: David Iben
Assets: $2.5 billion
Expenses: $143 per $10,000 invested
5-Year Average Annual Return: 11.7%
Comment: This six-year-old fund has relatively high fees and a shorter track record than most of our picks. But double-digit average annual returns make it worth a look.
Global Real Estate Funds
When Marc Halle took the helm at what is now the Prudential Global Real Estate fund at the beginning of 2007, his task was clear: transform a traditional domestic real estate fund into one that spans the globe. He shifted the portfolio to focus on foreign real estate, and the word global was added to the fund's name. So far, so good. Despite steep losses in the recession, the fund has managed to beat its peers by an average of nearly two percentage points a year during the past three years.
Global real estate funds are now enjoying a burst of popularity, with assets nearly tripling over the past five years, to $16.5 billion. And even though Halle has spent less time running his fund than the other winners in our survey, he has 25 years of experience investing in real estate. Today he draws on the expertise of Prudential's real estate arm, giving him a close-up view of deals around the globe. "I see what transactions we do," he says. "Who's buying, who's selling."
Halle says he prefers the developed world to emerging markets because of the greater transparency in accounting and corporate governance and the liquidity of the markets. He hasn't invested in Russia and prefers to get his exposure to Chinese real estate through companies based in Hong Kong or Singapore. Sun Hung Kai Properties, based in Hong Kong, was recently the fund's second-largest holding, after Simon Property Group (SPG)
Of course, real estate is subject to ups and downs no matter where it is. Prudential Global Real Estate tumbled 44 percent in 2008, only slightly less than the 47 percent decline of its peer group. That's one reason analysts say a global real estate fund should play only a supporting role in a diversified portfolio. Still, Lipper senior analyst Jeff Tjornehoj says that if the dollar continues to decline, global real estate funds could take off.
Prudential Global Real Estate
Manager: Marc Halle
Assets: $475 million
Expenses: $137 per $10,000 invested
5-Year Average Annual Return: 2.2%
Cohen & Steers Int'l Realty
Managers: Martin Cohen and Robert Steers
Assets: $1.4 billion
Expenses: $166 per $10,000 invested
5-Year Average Annual Return: 2.3%
Comment: The fund has had strong returns over its first five years, though the fees are on the high end. Top holdings include Hong Kong property developer Wharf and Australian developer Stockland.
ING Global Real Estate
Managers:T. Ritson Ferguson, Steven D. Burton and Joseph P. Smith
Assets: $2.9 billion
Expenses: $149 per $10,000 invested
5-Year Average Annual Return: 3.0%
Comment: The fund is divided between real estate stocks in the U.S. and abroad, and is managed by an affiliate of ING's Real Estate Group, one of the world's largest real estate firms.
U.S. Small-Cap Funds
Whitney George has a decidedly lowbrow way of describing his investment team. He says they're essentially "scavengers," with the portfolios they manage for Royce & Associates focused on small value stocks. No Apples or Best Buys or Cokes for this crew. Still, the strategy of looking for outfits that other fund managers avoid has paid off. The average annual returns of George's Low-Priced Stock fund exceeded 10 percent over the past decade a time when the broader market posted returns closer to zero.
Many of George's latest bets center on hard assets. He says that inflation might pick up because of the stimulus spending in developed nations and rising labor costs in countries like China and Mexico. That's led him to scoop up mining and energy stocks, which tend to do well during inflationary times. Although the shares of gold miners haven't kept up with soaring gold prices, George says the stocks could prosper even if prices for the metal stay around current levels. He likes silver even more than gold, because it's used in jewelry and electronics.
The emphasis on industrial materials has given the portfolio a global feel that is uncharacteristic of U.S. small-cap funds: More than 20 percent of the assets are invested in companies based outside the country. Many of the mining companies that the fund owns are based in developed markets but have operations in Africa or Latin America. When George does venture into emerging markets, he prefers health care and consumer-services stocks that could benefit from growing consumer demand in Asia and Latin America. Among his favorites: Value Partners, an asset manager in Hong Kong, and OdontoPrev, a dental-insurance company in Brazil. George says the Brazilian stock has tripled since he added it to the portfolio in late 2009.
George, 52, recently became co chief investment officer of the small-cap-oriented fund company, along with 71-year-old founder Chuck Royce. He's viewed as Royce's likely successor, says Morningstar analyst Karin Anderson. But he could be in for tougher sledding: Many analysts say that large stocks are selling at such steep discounts that they're poised to outperform small-cap stocks. George isn't buying it. He says that small stocks tend to do better in "low-return environments," because the companies are more flexible than big corporations. "Large caps do better in robust economies, like the 1950s and the 1990s," he says.
Royce Low-Priced Stock
Manager: Whitney George
Assets: $4.2 billion
Expenses: $149 per $10,000 invested
5-Year Average Annual Return: 8.4%
Heartland Value Plus
Managers: Brad Evans and Adam Peck
Assets: $1.3 billion
Expenses: $121 per $10,000 invested
5-Year Average Annual Return: 8.2%
Comment: This Milwaukee-based fund focuses on dividend-paying firms with strong balance sheets. Top holdings include financial and health care companies such as Omnicare (OCR),
Gamco Westwood Mighty Mites AAA
Manager: Mario Gabelli
Assets: $446 million
Expenses: $155 per $10,000 invested
5-Year Average Annual Return: 8.5%
Comment: This veteran fund manager focuses on companies with market value of no more than $300 million that he thinks are undervalued. Recently, the fund emphasized electronics and health care firms.