Value Added


5 Formerly Top-Performing Mutual Funds to Sell in This Market

Steven Goldberg

The "new normal" will not be kind to these funds and others like them. Look at your funds for these danger signals.



Bill Miller was the closest thing the mutual fund world had to a rock star since Peter Lynch retired as manager of Fidelity Magellan (symbol FMAGX) in 1990. But when Miller stepped down as manager of Legg Mason Value Trust (LMVTX) in November, he left behind a record decimated by six years of miserable performance.

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Legg Mason Value had famously beaten Standard & Poor’s 500-stock index 15 years in a row, a feat that has never been matched. But Miller’s hot streak turned ice-cold in 2006, and it remained that way to the very end of his tenure on Value.

And Legg Mason Value is hardly the only once-popular fund that I think you should sell. My reasoning is that the market environment today, following the disastrous 2007-09 downturn, is far different from what it was during the heyday of the bull market of the 1980s and 1990s.

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I’m confident that stocks will provide better returns over the next several years than they did during the first decade of the new century. But expecting annual returns of 10% or 15% is, in my view, naïve and dangerous. (For the record, between 1982 and 1999, Standard & Poor’s 500-stock index delivered calendar-year returns of more than 30% on five occasions and between 20% and 30% on five more occasions.)

We’ve been in a “new normal” environment since 2007. Stock and bond returns have been below par, and the economy has grown at a slower than normal pace -- with heightened risks of downturns. The new normal is likely to last for several more years.

Following are five often-praised funds that I think you should sell. For each fund, I single out one dangerous trait, but, in truth, all of these funds display multiple risks.

Legg Mason Value

The secret to Bill Miller’s success was that he never gave up on a stock. The more it tumbled in price, the more he bought. So when the stock finally turned upward, Miller held a boatload of shares.

What’s different now? Miller recently gave The New York Times the answer. “Contrarian value-based investing just isn’t working anymore,” he said. “Stocks go down further than the historic metrics would indicate -- and they stay down.” The lesson: Be careful of value managers who specialize in badly beaten-up companies.

Look at Miller’s recent record. Over the past five years, Value lost an annualized 9.4%, while Standard & Poor’s 500-stock index was roughly flat (all returns in this article are through December 6). Recent results have been so pathetic that they make Miller’s long-term record look like the work of an amateur. Over the past 15 years, Value now trails the S&P 500 by more than one percentage point per year, on average.

Miller, by the way, remains at the helm of Legg Mason Opportunity (LMOPX), a smaller fund that is more aggressive than Value and has done even worse in recent years. If you own Opportunity, sell it, too.

Longleaf Partners (LLPFX)

Longleaf Partners is a highly regarded fund. In fact, Morningstar just named it one of a handful of “gold” funds, which under a new forward-looking rating methodology is the rating firm’s strongest endorsement. I respect Morningstar, but I think its analysis is wrong this time.

The problem: Longleaf is too volatile. Based on the past five years, the fund is one-third more volatile than the S&P. Eventually, funds almost always pay the price for high volatility. (See VALUE ADDED: Consider a Fund’s Volatility -- or Risk Paying a High Price.)

Over the past ten and 15 years, Longleaf still ranks in the top 12% among funds that invest in large companies with both a value and growth bent. But Longleaf lost 64.8% in the 2007-09 bear market, compared with a 55.3% drop for the S&P index. Despite good performance since, the fund has lost an annualized 3% over the past five years and ranks in the bottom 10% among its peers for that period.

Longleaf, like Miller, buys a handful of deeply depressed stocks that it thinks will recover, then holds on patiently. The managers, who are hardworking and highly disciplined, pay no attention to sector weightings. A compact portfolio such as Longleaf’s typically leads to high volatility. And when the economy is fragile, stocks in the bargain bin sometimes just keep going down.

Bridgeway Aggressive Investors 1 (BRAGX)

This fund was long one of my favorites. John Montgomery writes computer programs that pick stocks to buy and sell. For fear that others would copy his methods, potentially undermining his performance, Montgomery refuses to share too many details. The lesson: Beware of investment disciplines you don’t fully understand.

The 2007-09 bear market was Bridgeway Aggressive’s Waterloo. It plunged 64.4%, 9.2 percentage points more than the S&P. Over the past five years, the fund lost an annualized 6.4%, an average of six percentage points per year worse than the S&P. The fund’s 15-year record is still fairly good. But that’s all that’s left.

CGM Focus (CGMFX)

CGM Focus still boasts a fabulous long-term record but little else. Over the past ten years, Focus returned an annualized 7.8%. That’s an average of 5.1 percentage points per year better than the S&P and good enough to place the fund in the top 1% among large-company-growth funds.

Manager Ken Heebner is known for his huge, and rapidly changing, sector bets. When he is on, his results are scintillating. But this isn’t Heebner’s kind of market.

He has beaten the market only twice in the past five years. Over that stretch, the fund lost an annualized 1.7%, including a 22.7% loss so far this year.

The lesson of CGM Focus is to avoid funds that try to time their exit and entry into a market sector or two. Today’s market is too unforgiving of bad bets. Being bold is generally a bad idea.

Fairholme Fund (FAIRX)

I don’t mean to pick on Bruce Berkowitz, about whom I recently wrote critically. But hubris is such a dangerous trait in a fund manager that you should always be on the lookout for it. When a manager doesn’t have a talented team of analysts supporting him -- or when the analysts he does have keep leaving -- when a manager, in other words, is practically working solo, be very careful before you invest.

Some superb managers, notably Oakmark’s David Herro, are as humble and cautious as can be but have trouble holding onto analysts. But Herro, who runs Oakmark International (OAKIX), is part of a great firm. Berkowitz runs his own firm, and he calls the shots. Therein lies the problem. There is no one to rein him in.

Like the other funds in this article, Fairholme boasts a great long-term record. Over the past ten years, the fund returned an annualized 7.5%, an average of 4.8 points per year better than the S&P. But so far in 2011, it has tumbled 27.9%. Berkowitz’s mistake: He put more than 75% of Fairholme’s stock assets into financial companies. I believe Berkowitz made the mistake of believing his own press clippings. Now his shareholders are paying the price.

Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area.



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