The economic downturn has made it easy for investors to see how a few bad stock picks can sink a good mutual fund.

Oakmark Select (OAKLX) was a decent-rated fund heading into 2007. But then a sizable position in Washington Mutual imploded as the bank succumbed to the mortgage and credit crises. The fund lost 14% that year, 19 percentage points behind the broad market. To his credit, Oakmark s manager, Bill Nygren, was very candid about the performance: It was "dreadful," he said in a special letter to shareholders.

Oakmark Select is what we call a "focused" fund an offering that has fewer than 50 stocks in its portfolio. Usually the funds we look at own around 100 to 150 stocks. Focused funds concentrate their cash in just a few dozen. That means the typical stock accounts for a large percentage of assets, allowing for big returns when it rises in value and big losses when it doesn t.

"If you have one mistake or two mistakes, you are going to run into a portfolio that will underperform its benchmark," says Jeffrey Ivory, an advisor with Stonebridge Financial Partners in Bingham Farms, Mich.

We used Morningstar s fund screening tool to narrow an initial universe of 6,301 funds and share classes that have fewer than 50 stocks. We then knocked out funds that charge a sales load and others that didn t meet our usual fee and performance criteria. Because focused funds carry more risk, we also required each one to have a manager who had been in place for more than five years. Experience puts our minds at ease, especially when it comes to making oversized bets in a mutual fund. Once we finished screening based on those criteria, we were left with 18 funds. (See the table below.)

The decision to invest in a focused fund is usually rooted in the long-standing debate over passive vs. active management. Some investors believe it is folly to think a manager can outperform over the long term, so the best alternative is to put money into an index fund that will mimic the returns of an underlying benchmark like the S&P 500 at a low cost. We'll call this camp the Vanguard Crew.

However, several studies have tried to determine the number of stocks an investor must hold in order to be adequately diversified and it appears that can be accomplished with far fewer than 500. Indeed, in his book, "You Can Be a Stock Market Genius," Joel Greenblatt, founder of hedge fund Gotham Capital, says investors can cut the nonmarket risk the part of a stock's risk that isn't tied to the day-to-day movements of the broad market of owning one stock by adding another one to the portfolio. In addition, risk can be cut by 81% by owning eight stocks. Interestingly, once the portfolio contains eight issues, "the benefit of adding even more stocks to your portfolio in an effort to decrease risk is small," Greenblatt says.

Is there common ground in the debate of owning just eight stocks vs. 800? Hany Shawky and David Smith, professors at the University at Albany, conducted a study that discovered a relationship between the number of stock holdings and risk-adjusted returns. "[We] found that too few or too many stocks lead to diminished performance in actively managed equity portfolios," Smith wrote in an email. Smith says that funds that held 100 to 150 stocks produced higher risk-adjusted returns over time than those holding 30 or 35. Meanwhile, they also surmised that managers who bought several hundred stocks weren't investing with conviction on each and every stock.

And that's what brings many investors back around to focused funds. If investors truly believe in paying up for a manager's stock-picking prowess, it would seem logical that they would only want him putting money in his best ideas.

There are several funds on our list we would suggest checking out, including Chase Growth (CHASX), FBR Focus (FBRVX), Hussman Strategic Growth (HSGFX) and Westport (WPFRX). Forester Value (FVALX), meanwhile, was the only equity fund to record a positive return in 2008. We also think highly of Fairholme (FAIRX). Manager Bruce Berkowitz uses a Warren Buffett-esque value investing style that has produced above-average returns for much of the last decade.

So what about Oakmark Select? Nygren steered it to a 36.2% loss last year, slightly better than the broad market, and now the fund is in the top 4% of its category in 2009. Sounds like the makings of a comeback to us.

The Criteria

The funds on our list have portfolios of fewer than 50 stocks. They are open to new money, require less than a $5,000 minimum initial investment and charge less than a 1.5% annual expense ratio. Their track records during the trailing three- and five-year time periods put them in the top 25% of their peer groups. In addition, the funds managers had to be in place for at least five years. We did not include load funds.