SmartMoney.com's Best Funds of 2008

Welcome to SmartMoney.com's third annual ranking of the fund industry's best offerings. Over the last 12 months we conducted hundreds of interviews with fund managers, financial advisors and industry experts, looked at the portfolios of dozens of mutual funds and tracked return data through some of the worst conditions the stock market has ever seen. And that has led us to this: Our winners in seven key categories. In two additional categories we give kudos to some newcomers as well as a fund that managed to claw its way back to the top last year. We think the names on this list are worthy of consideration for a spot in your portfolio.

While we use a wide range of criteria to ultimately make our top picks, by far the most important one is performance during the previous year. The average domestic equity fund dropped 37.6% in 2008; world equity offerings fell a startling 45.8%. The funds we considered for this list were at least in the top 10% of their individual Lipper categories return-wise in 2008. That means they were able to stem some of the bleeding.

Financial advisors call that preserving capital. It sounds good on paper. And, admittedly, we do see merit in being able to hold losses to a minimum in down markets. But it will nevertheless still be a painful realization to readers that most of the funds we looked at had good years because they were able to lose only 30% or 25% or 20%. Indeed, just one domestic equity fund, Forester Value (FVALX), managed to finish in the black. It eked out a small 0.4% gain during 2008.

We don't solely rely on 2008 numbers because we don't want to reward a one-hit wonder that'll flame out just as fast as it showed up on the scene. Our mutual fund winners have decent three- and five-year track records, managers who have proven themselves through thick and thin and the offerings charge minimal fees. We also listened to our readers, who submitted candidates during December. One recurring theme among all the winners: a deft ability by the managers to avoid or at least sidestep the credit crisis. Also, we usually exclude load funds from our screens, but for this one we allowed load and no-load offerings to go toe to toe.

The nontraditional categories -- ETF, Newcomer and Comeback -- are more subjective. The ETF winner is usually a fund that has had a profound impact on the industry vs. anything to do with performance. In that case, we look at trading volume, asset accumulation and general investor buzz. The Newcomer designation is bestowed on a fund that launched during the year and either had a novel approach to investing or a good performance run during its first few months. The Comeback refers to a fund that was down in the dumps at one point but jumped back into the top 10% of its Lipper category during 2008. We hope this last category is an extremely competitive one next year.

Before we announce this year's winner we feel compelled to look back at the Best of 2007 to see how those funds have done since receiving our accolades. Unfortunately, we don't have much good news to report, proving, once again, that 2008 didn't discriminate when it came to whacking all kinds of mutual funds and their managers.

Of the five main fund winners we proclaimed last year, only one, Thornburg International Value (TGVAX), managed to remain near the top of its class. Our midsize-company winner, CGM Focus (CGMFX), did a complete about-face. Manager Ken Heebner shorted financials and heavily bought energy stocks in 2007, which led to an astounding 80% return that year and a perch firmly atop his Lipper classification. This year he cycled out of energy and bought financials like Bank of America (BAC) and Citigroup (C). (The fund has been reclassified as a large-cap offering.) That hurt him the second half of 2008 as financials continued to struggle. And the fund ultimately lost 48.2%, putting it in the bottom 4% of its current category. We wouldn't bet against Heebner, though. He appears to be setting the fund up for a rebound he sees later this year and in 2010. We have confidence he will once again be competing for a spot on this list.

On the following pages, you'll see the winners from each of these categories.