7 Once-Stellar Funds Poised for a Comeback

Lately it seems like whenever we talk to advisors and industry watchers, there's one fund family that generates the most discussion: Dodge & Cox. The venerable 78-year-old firm got caught this year holding stocks like Fannie Mae (FNM), AIG (AIG) and Wachovia (WB) as those companies spiraled downward. That's caused the flagship Dodge & Cox Stock (DODGX) mutual fund to post a 47.7% loss in 2008, worse than the S&P 500 index's 41.1% decline and far worse than a majority of competitors.

That's an unaccustomed place for this company. Its funds ordinarily are ranked high in their respective categories, not near the bottom of them. Indeed, Dodge & Cox Stock has returned an average annual 4.4% the last decade, a tally that puts it near the top of the large-cap value category, one of the most crowded (and competitive) groups in the industry.

That leaves shareholders wondering: Will Dodge & Cox make a comeback? While we think the answer is an unequivocal yes, we also realize we don't have a crystal ball. Unfortunately for investors there are plenty of other funds out there that sport a similar penthouse-to-the-doghouse track record. They are all left pondering what to do.

This week we're focusing in on these funds. We started with a universe of 163 offerings that have stellar track records over the trailing decade but also were in the bottom 40% of their peer groups the last three years. We knocked out 114 that charged sales loads and then we added in our usual fee criteria. We were left with 28 equity funds. We handicapped that list by picking seven we think will return to form based on advisor interviews, managers' reputations, past track records, strategy and the funds' current portfolios. The finalists are listed on the table below.

We realize that every fund can't post consistent, above-average returns year after year. It's just not possible. Indeed, even the industry's best managers experience a rough patch every once in a while. The trick is to find out why the fund is experiencing a downturn and whether it's a signal to exit it and find another investment or stick it out until things get better.

Whenever we have done this screen in the past, we instantly check for two things: Whether there has been a manager change at a given fund, and whether the fund is veering from its usual strategy. The problem with focusing on a fund's past performance is that it is just that -- in the past. Investors can rest a little easier knowing the person who crafted a stellar record might be able to get his charge back on track. If that manager has moved on, then all bets are off. Similarly, we would raise red flags if a fund that never invested in, say, energy followed the pack when the sector got hot the last 18 months only to see it cool off (along with the fund's returns).

This year, in particular, there's another set of caveats keeping funds down. The unprecedented market calamity caused by the credit crisis has dinged both good and bad companies alike. Even thorough stock research wouldn't have been able to help a manager anticipate the historic government intervention that has taken place. And any stock-picking strategy -- regardless of what it has experienced in the past -- has certainly been tested this year as a volatile market can move by several percentage points on any given day.

We can forgive a bad stock pick or two, especially under these circumstances. And we admire a manager who sticks to a time-worn strategy even as it looks like the rest of the industry is headed in the other direction. What always give us pause, though, is trying to predict whether a fund is still a worthy investment or not. Our track record in this endeavor is decent but not stellar. (Click here and here to see the last two installments of this screen.)

Mairs & Power Growth (MPGFX) made this list last year. The fund, which invests primarily in a basket of stocks that are headquartered in or around its home city of St. Paul, Minn., has managed to crawl back into the top decile of its category in both the trailing three-year and 10-year time periods. Muhlenkamp (MUHLX), also on last year's list, is still struggling but improved enough to make an exit. Three  funds from the screen we did in June -- Jensen Portfolio (JENSX),  Oakmark International (OAKIX) and Marsico Growth (MGRIX) -- have fallen off the list this time around. However, we also said Al Frank (VALUX) and Chesapeake Core Growth (CHCGX) would pull off a similar feat. They didn't (although we would be surprised it that didn't happen the next time around).

This time we're forecasting a return to normalcy for Dodge & Cox Stock and its sister fund, Dodge & Cox Balanced (DODBX). We were a little hesitant about making this call, especially after seeing in the last round of SEC filings that the company owned or was buying General Motors (GM), which, if it pans out, will go down as an amazingly gutsy call. But if you look at the overall portfolios they are chuck full of well-run companies trading at a discount despite decent earnings projections. We think the market will come back around to those stocks -- and these funds, too.

The Criteria: The equity funds on our list have track records that put them in the top 20% of their peer groups over the trailing decade and in the bottom 40% of those same categories during the last three years. They are open to new money, require a minimum investment under $5,000 and charge an annual expense ratio under 1.5%. We didn't include load funds in this screen.

* The screen only includes equity funds