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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.
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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 (ticker: 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 million 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.
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Delafield's Vincent Sellechia and Dennis Delafield
"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), a machine-tool maker whose orders were up 27% for the three months through Aug. 31. The stock fell 32% in three weeks of panic-selling from July 19 through Aug. 8. They believe it will recover nicely as demand for machine tools surges in emerging markets.
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 protégé 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), is a stock Coons had previously dismissed as overpriced. But the shares fell more than 20% in late summer, and he believes they can retrace that move. Coons expects Amazon's earnings to grow at a compound annual rate of more than 40% over the next three to five years, mainly because of the online retailer's vast potential to grab market share from bricks-and-mortar merchandisers.
Jeffrey Coons
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 (BA) and one of its suppliers, Spirit Aerosystems Holdings (SPR).
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.
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Oakmark International's David Herro
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.
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), which makes brake systems for trucks, Halliburton (HAL), the oil-service outfit, and Watson Pharmaceuticals (WPI), a generic drug maker.
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.
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Lord Abbett's Robert Fetch
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