Many good companies go through dry spells: their strategies fall flat, or don't produce the stellar results Wall Street had come to expect. And investors don't hesitate to jump ship. But what's sometimes left behind -- think McDonald's, Nike, IBM or Coca-Cola -- is a resilient executive team that adapts, or simply decides to press ahead until sentiment changes. Those can turn out to be great stock picks.
The same can be true of good mutual-fund managers.
A number of experienced, well-respected hands with top-tier long-term track records have seen their performances fall off the charts this year, particularly this past summer. So we decided it was a good time to look for some possible bargains for fund investors. With the help of Lipper, we screened through hundreds of candidates searching for portfolio managers whose funds had a decade of excellent performance, but had seen their net asset values shrink in 2011 and their rankings slip badly.
"The idea is that you have somebody who has previously found great reward in the market, whose ideas have been appreciated by others eventually, but they have sunk low," says Jeff Tjornehoj, head of Lipper Americas Research. "Did they completely lose their talent overnight? I doubt that. Instead, you are able to buy their portfolio at a discount."
Research does suggest there's a performance pendulum swinging over time. A recent study by Michael Mauboussin, chief investment strategist at Legg Mason Capital Management, found that mutual funds that performed in the bottom quartile in the 1990s rose an average of 7.8 percentage points in the 2000s. Funds in the top quartile in the '90s fell by the same amount of percentage points.
Aside from good long-term returns and reliable management, we've also tried to create as diverse an equity group as possible. Making our cutoff was Vincent Sellechia (with co-manager Dennis Delafield) of the Delafield Fund (DEFIX): Jeffrey Coons of Manning & Napier Equity Series (EXEYX); David Herro of Oakmark International (OAKIX); Robert Fetch of Lord Abbett Fundamental Equity Fund (LDFVX); and Bert Boksen of Eagle Mid Cap Growth Fund (HAGAX).
Each manager's situation differs -- Eagle's Boksen concedes he "made a bad call" on cyclicals and tech, and Coons got too reliant on companies with government contracts -- but they all shared the same pain. Fetch notes that although Fundamental Equity invests across all market capitalizations and employs varied strategies, it didn't get any offsetting breaks to cushion the market's blow. Fundamental Equity's NAV has fallen by 18.4% since July 7. And yet, the fund's 10-year average annual gain is a healthy 5.4%, better than 83% of the multi-cap core funds that Lipper tracks.
"More than at almost any time in history, correlations within the market are at all-time extremes, meaning the vast majority of stocks are moving with the market," says Fetch, who has more than 30 years of experience.
That situation won't last. Lewis Altfest, chief investment officer at Altfest Financial Management in New York, who manages more than $100 billion for high-net-worth investors, started moving some clients into Oakmark International in late September. He was impressed that portfolio-manager Herro had stuck to his beliefs and had even increased his bet on miserably performing European banks.
"It's better to get into a fund when it's underperforming than when it's at the top of its game," says Altfest. "The ones that have just done outstanding are vulnerable to a temporary decline." We agree, and so here's our list of five of the most promising underperfomers.
Co-managers,Vincent Sellechia and Dennis Delafield
10-Year Avg. Return:9.6%, 2011 Return: -16.2%
It's not too hard to spot the drag on Delafield's recent performance. The $1.1 billion vehicle keeps about twice the typical mid-cap value fund's investment in industrial stocks, which are very sensitive to the sputtering U.S. economy. But veteran co-managers Vincent Sellecchia, 59, and Dennis Delafield, 75, have seen this all before and view it as an opportunity.
The two have been busy snapping up shares of efficient manufacturers that have gotten hammered. Following a simple formula since their start in 1993, they focus on a company's liabilities in order to calculate how much it will "cost" to own the shares for a couple of years. They're willing to absorb a loss for a year or so while waiting for other investors to recognize the company's earnings prospects.
"We take advantage of what the market presents to us during downturns, and that becomes the fuel for our performance in subsequent quarters," says Sellecchia.
He is "very comfortable" with the stocks in the fund, even though it lost 16.2% of its value year-to-date, well behind the Standard & Poor's 500's 7.4% decline. The fund has lagged behind 90% of its peers. Arthur Cohen, a financial advisor in North Brook, Ill., who has put his clients' money into Delafield, is confident that performance will snap back toward the fund's 10-year record of a 9.6% annualized return before long. That 10-year gain beats 90% of the fund's rivals.
Delafield fell 37.6% in 2008, slightly worse than the S&P 500's decline. Then it came roaring back in 2009, delivering a 54.9% return -- nearly double the S&P's rebound.
The managers have bought more of their favorite stocks. One is Kennametal (KMT),
Manning & Napier Equity Series
Manager: Jeffrey Coons
10-Year Avg. Return: 5.1% , 2011 Return: -11.5%
Jeffrey Coons clears his head every morning with a six-mile run at 4 a.m. A protege of growth investor Bill Manning since joining Manning & Napier in 1985, straight out of the University of Rochester, Coons needs to stay cool and collected these days. His Equity Series fund has fallen 11.5% this year, behind 75% of his multi-cap growth-fund peers. There's reason to believe he'll be back. The fund has fallen short of the Russell 3000 during 54 different six-month periods, but it's beaten the benchmark in 99 six-month periods. Over nearly 10 years, Equity Series is up 5.1%, twice the gain of the S&P 500, and better than 92% of its rivals, says fund researcher Morningstar.
The $1.8 billion Equity Series has thrived by buying growth stocks whose earnings are rising at a multiple of the U.S. economy. Using discounted-cash-flow analysis, Coons aims to select stocks that can rise at least 20% within two years. A recent example, Amazon.com (AMZN),
By seizing such opportunities, Coons, 48, hopes to improve Equity Series' performance, which he notes has been hit by the unusually high correlation of losses across styles and capitalizations. In another recalibration, Coons has been selling stocks that depend on government spending, which he expects Washington to cut. He's shed shares of Boeing (BOA)
Says Coons: "Markets turn very quickly, and this market is quite volatile. We think we are quite well-positioned."
Manager: David Herro
10-Year Avg. Return: 8.9%, 2011 Return: -14.3%
If you don't believe the world -- or perhaps just Europe and Japan -- is about to end, then this could be the fund for you.
David Herro's well-regarded Oakmark International is concentrated in European banks and in Japanese and European industrials whose shares collapsed along with their economies this past spring and summer. A dyed-in-the-wool value investor, he has been combing through his holdings, buying more of the stocks that he believes have been unfairly trampled. An avid bicycle racer, Herro says he knows that every steep downhill is followed by a steep uphill and "you always end up where you started."
Herro, 50, is on a tough uphill stretch right now. He likes some of the banks that other investors have dumped as Europe's sovereign-debt woes spread. Among them is BNP Paribas (BNP.France), which has fallen 41% since midyear, and Banco Santander (SAN.Spain), which has dropped 25% since mid-February. Oakmark has also been a big buyer of car-maker Daimler (DAI.Germany), which is down more than 40% since late July. And, if that's not bucking sentiment, Herro also bought shares of Toyota (7203. Japan) after the tsunami.
He's willing to wait two to five years for these bets to pay off. "We are wildly positioning ourselves for when things come back, while most people are probably headed toward safety," says Herro, who's been running the $7.1 billion fund since 1992. "Usually, it's after periods like this that we do the best."
The fund surged 39.5% in 1999, a year after it fell 7% as the dust settled from the emerging-markets crisis. And it jumped 56.3% in 2009, after nosediving 41.1% in 2008.
Herro expects BNP Paribas to cover its Greek exposure of 3.5 billion euros ($4.7 billion) with 15 billion of profit this year. He's confident in Banco Santander, because Brazil now accounts for more of its profit than indebted Spain.
Clients are undaunted by the fund's 14.3% drop this year, a worse showing than 65% of Lipper's international large-cap core funds. Oakmark had net inflows in the first seven months of 2011. If Herro is right, in a couple years, his performance will revert toward his 10-year record, which includes annualized 8.9% growth, beating 93% of his peers.
Lord Abbett Fundamental Equity
Manager: Robert Fetch
10-Year Avg. Return: 5.4%, 2011 Return: -11.8%
When Robert Fetch, just out of Seton Hall's MBA program, started managing equity portfolios in the 1970s, the fund world didn't have value and growth boxes. But by the time he took over the Lord Abbett Fundamental Equity Fund in 2001, he'd honed his own value style of stock-picking.
He hunts for companies of all types and sizes that offer strong earnings growth at reasonable valuations. Fetch wants to buy shares whose potential increase in price is three times greater than its risk, as measured by standard deviation. For a decade, the drivers of Fetch's $3.8 billion fund were industrial, energy and health-care stocks, which more than doubled in his two-year investment horizon. Among them were Wabco Holdings (WBC),
Because of his emphasis on value, Fetch, 58, avoided much of the dot-com crash when he ran a similar institutional fund. His price-conscious approach also steered him away from banks before 2008's mortgage crisis. The fund is up 5.4% for 10 years, topping the S&P 500 Index by almost two percentage points and beating 81% of his multi-cap-core peers.
Fetch believes many of the stocks in his portfolio got hit even though they're less directly affected than others by weak economic growth, a shrinking job market, or the inability of the U.S. and the European Union to manage their debt. So far this year, the fund, which owns 106 stocks, is down 11.8%, behind 79% of its peers. Among its worst laggards were Ford Motor (F),
Like Herro, Fetch is a man of conviction. He's buying up some of the fastest-falling stocks in his portfolio because he sees promising fundamentals and low prices. A case in point is Ford, which reported its biggest profit in 11 years for 2010. Ford CEO Alan Mulally understands the auto industry well enough to keep cutting costs, paying down debt and rolling out popular new models, says Fetch. Americans, he notes, are just itching to replace aging cars.
Lipper gives this fund its highest ratings for consistent returns and capital preservation, which suggests it can regain its form, says research director Tjornehoj.
Eagle Mid Cap Growth
Manager: Bert Boksen
10-Year Avg. Return: 8.6%, 2011 Return: -13.9%
Anyone investing in Eagle Mid Cap Growth right now is "picking a point in time that is probably unique," says veteran manager Bert Boksen. "We have never been in the bottom quartile before."
Over the last 10 years, the $325 million fund is up 8.6%, well above the S&P 500's 5.3%. That puts it in the top 4% for mid-cap growth funds. It's down 13.9% so far this year, dropping it to the 86th percentile.
Part of the problem has been its cyclical and tech holdings, some of which Boksen is selling. The worst-performing stock was coal producer Walter Energy (WLT),
Among its weakest tech stocks was Akamai (AKAM),
Boksen focuses on companies with accelerating earnings growth, strong balance sheets and some sort of catalyst to kick-start the shares' upward move. He's searching for stocks that can rise at least 20% within two years. Boksen hedges his bets by avoiding big stakes in a single stock or single sector.
The strategy allowed Eagle Mid Cap to minimize its losses in the 2000 dot-com crash, when it fell less than a percentage point versus the broad market's 10% decline, though it performed slightly worse than the S&P 500 Index in 2008's meltdown.
Based on Boksen's record, Morningstar analyst Janet Yang expects the fund to resume its strong performance.
The manager has changed course a bit to focus on cheap stocks that aren't cyclical and can deliver decent returns even in a lethargic economy. "We like areas that are stable, like vitamins, beauty supply and health care," says Boksen, who keeps a drawer full of vitamins and fish-oil tablets in his St. Petersburg, Fla., office.
Eagle Mid Cap has added Sally Beauty Holdings (SBH),
As with all five of these funds, a little stability in the portfolio would be a welcome relief.