The 25 Best Funds
Seven new names join our list of favorites.
These are the times that try investors' souls. The stock market is cracking. The housing bubble is deflating. Credit markets are frozen and banks are nursing self-inflicted wounds. The economy may have lapsed into recession. Even normally dull corners of the investment world, such as municipal bonds, are jittery.
At some point the cycle will turn -- it always does -- and the future will look brighter. We can't tell you when it will occur. But we can help you meet your long-term financial goals by constructing a well-diversified portfolio of the best mutual funds.
|NEW! Visit the Kiplinger 25 Center for Year-Round Updates|
|Key Data for the Kiplinger 25|
|Suggested Portfolios Using the Kiplinger 25|
|What's Changed Since Last Year|
|Fund Rankings by Performance|
|Sign Up for Kiplinger 25 E-mail Alerts|
To help you build your nest egg, we have surveyed the universe of thousands of funds and selected the best stock and bond funds for our annual Kiplinger 25 list. This year, we include a commodity fund for the first time.
We consider only funds that do not levy upfront or back-end sales charges (redemption fees that disappear after a month or two are okay). And we prefer funds that charge below-average annual fees.
We closely examine fund managers' track records -- the longer, the better -- and listen carefully to how they describe their investment strategy and style. We compare their performance with the risk they bear.
We look for managers who know their stocks intimately, tend toward low turnover (with certain exceptions) and have the discipline to adhere to an investment style through rocky market periods. We favor managers who care about the preservation of your capital, although we are willing to recommend aggressive funds if the returns they have produced are commensurate with the risks they've taken. Finally, we give extra credit to managers who talk freely about their investment blunders and the lessons learned.
Investors have different investment styles, needs and time horizons, too. Therefore, we suggest three different portfolios composed of funds drawn from the Kiplinger 25.
Large-company stock funds
Longleaf Partners (symbol LLPFX). Even if you're not overly confident in the stock market's immediate prospects, this is a good time to open an account with Longleaf Partners. The fund has a habit of closing to new investors when its managers think it's growing too large to invest efficiently. In fact, Longleaf recently reopened after being shut for more than three years.
Run by Memphis-based Southeastern Asset Management, Longleaf has a long history of doing right by its shareholders. Closing to new investors is one way this is manifest. In addition, SAM employees are required to put all of their stock money in Long-leaf funds.
Performance hasn't been too bad, either. Under Mason Hawkins and C. Staley Cates, who head a team of nine analyst-managers, Longleaf has returned an annualized 13% over the past 20 years to March 10, an average of two percentage points per year better than Standard & Poor's 500-stock index. But don't expect Longleaf's returns to march in lock step with the index. That's because Hawkins and his team adhere to strict value-investing principles and pay no attention to sector weightings.
When evaluating potential investments, Longleaf's managers focus mainly on three issues. First, they seek good businesses, by which they mean companies that are insulated from competition, generate strong free cash flow (the money left after making the capital outlays needed to build or maintain the business) and have plenty of growth opportunities. Next, they seek quality executive teams, preferably owner-operators and certainly managers with capital-allocation skills to maximize the use of that abundant free cash flow.
Finally, the price must be right. The fund buys a stock if it is selling for 60% or less of Longleaf's calculation of the company's intrinsic value. Once the managers buy, they hold stocks for an average of five years.
As you might expect, the portfolio is eclectic. The largest holding at last report was Dell, the personal-computer maker. The moat protecting Dell is its low costs and its unmatched direct-to-customer sales. The company generates huge amounts of free cash. In addition, founder and chief executive Michael Dell is a large shareholder and, in Longleaf's estimation, knows how to invest company cash.
Dodge & Cox Stock (DODGX). Dodge & Cox Stock made a hefty investment in Wachovia Bank in late 2006. The bank's shares sank in 2007 with the rest of the financial sector. So what did Dodge & Cox do? It doubled up and raised its stake in the bank to 4%. "We're patient and persistent," says John Gunn, one of the fund's nine managers and chairman of the San Francisco-based fund family.
Their discipline pays off for shareholders. Over the past 20 years, Stock -- which, like Longleaf, recently reopened to new investors -- has returned more than 13% annualized. Not many large-company stock funds can match that record.
Although Dodge & Cox is known as a classic bargain-hunting shop, Gunn says the managers want growing companies that sell at attractive prices. For instance, Stock has loaded up on big drug makers, such as Novartis and Glaxo, both based in Europe. Gunn says the major drug companies are selling at the lowest measures of value in 20 years. The fund's largest position is Hewlett-Packard, which, Gunn says, neatly encompasses two "tidal forces acting out the next three to five years": the swift pace of technological innovation and growth prospects for 5.5 billion people in the developing world, who are steadily plugging in to the global economy.
T. Rowe Price Equity Income ( PRFDX). Brian Rogers has run T. Rowe Price Equity Income since the fund began in 1985. So he's survived a wicked cycle or two. He sees shades of the 1990 real estate bust today, except that this time it's residential instead of commercial property. His advice: "Don't get irrationally depressed. The world doesn't end that often."
Instead, Rogers is picking up companies with strong balance sheets and staying power, such as General Electric and McGraw-Hill. The market could take a while to turn around, but Rogers reckons that if you look out three years, it's hard to imagine that a portfolio of high-quality companies paying regularly rising dividends won't beat, say, the return on five-year Treasuries.
T. Rowe Price Growth Stock (PRGFX). Rob Bartolo has wasted no time in putting his stamp on T. Rowe Price Growth Stock since taking the reins in October 2007. His quick response to sick credit markets and a weakening economy was to turn defensive. He tossed out shares of some vulnerable financial and economically sensitive companies and added durable growers (he seeks at least 12% annual growth), such as health-care companies and makers of consumer necessities.
In the health-care realm he particularly likes companies that are not vulnerable to the whims of federal regulators and politicians, such as Laboratory Corp. of America. Like Rogers, Bartolo has been a big buyer of McGraw-Hill and GE.
Vanguard Primecap Core (VPCCX). The press-shy, six-man team that runs Vanguard Primecap Core also evidently thinks health care is a nice place to be in 2008. The group has raised the fund's allocation to this sector over the past year, buying stocks such as Amgen, Novartis and Medtronic. The managers at Primecap, which is based in Pasadena, Cal., look for growth but are sensitive to a stock's value. They conduct thorough research and typically hold stocks for seven to ten years -- an eternity by the standards of today's mutual funds.
Marsico 21st Century (MXXIX). Cory Gilchrist's Marsico 21st Century has returned an impressive 20% annualized over the past five years, an average of nine percentage points per year ahead of the S&P 500. But Gilchrist thinks global economic growth will slow this year and is adjusting his investment strategy accordingly. He's avoiding companies that rode the wave of price increases and raw-material shortages during the robust global economy of the past five years.
Gilchrist says he's seeking outfits that are capable of producing more of whatever it is they make. For instance, Petrobras is one of his favorite energy stocks because of the Brazilian oil giant's rapidly growing offshore reserves. The boom in Brazilian agribusiness is one reason he's a big fan of seed-tech powerhouse Monsanto, which enjoys a "unique position in agriculture in the world." Gilchrist thinks Monsanto can sustain 25% annual growth for more than five years.
Selected American Shares (SLASX). You might expect Chris Davis of Selected American Shares, a heavy investor in financial stocks, to be shaken by the credit crunch. But no: Davis, who runs the fund with Ken Feinberg, says he subjects his holdings to a stern stress test before investing.
For example, he asks if their balance sheets are strong enough to withstand adverse developments and if their sources of funding are diverse. "We recognize that we will own every financial we buy during a recession and during periods of rising financing costs," he says. He wants companies that will not only survive market volatility but also continue to compound earnings and book value (assets minus liabilities) over the long run.
So he's content to hold on to large stakes in such deflated stocks as American Express and Wells Fargo, figuring that these strong franchises will rise again. And he's investing in shares of beaten-down financials, such as Merrill Lynch. Davis's patience, sense of value and unflappability go a long way toward explaining how Selected American has consistently outpaced the S&P 500 over extended periods of time.
Small- and midsize-company funds
Baron Small Cap (BSCFX). Warren Buffett counsels that stock investors should stay within their circles of competence. By this he means pick your spots carefully, invest in what you understand, and give a wide berth to that which you don't comprehend. Cliff Greenberg, the skipper of Baron Small Cap, seems to have taken Buffett's insight to heart.
The universe of small companies is vast, but Greenberg sticks to what he knows. He says he shuns most technology and biotech companies. He's not a techie and, more important, it's inherently difficult to project the long-term future and earnings of most tech companies.
Instead, Greenberg prefers some rather mundane but lucrative consumer businesses, such as hotels, gaming and for-profit education. Ron Baron's impressive family of small- and midsize-company funds has long dined on these industries.
For instance, Baron previously made a killing in shares of the Four Seasons Hotels. Greenberg thinks Mandarin Oriental, a Hong Kong-based owner and manager of luxury hotels, can replicate Four Seasons' success in expanding its global footprint. In Gaylord Entertainment, he sees Las Vegas-style megahotels with lucrative convention centers and restaurants. In for-profit education, Greenberg cut his teeth on pioneers such as Apollo and DeVry, sold them after multiplying his money, and has moved on to companies that focus on online education and advanced degrees, such as Strayer and Capella.
Greenberg likes to keep about 90 names in the portfolio, which he turns over every three years, on average. When stocks run up -- as have SunPower, FLIR Systems (two of his top ten holdings) and Intuitive Surgical -- he'll trim his positions. When prices become really outrageous, he sells all of the shares and moves on to the next idea. "I don't want to be a pig," he jests.
Greenberg is one talented stock picker: Since Small Cap was launched in September 1997, with Greenberg at the helm, it has returned an annualized 9%, nearly double the gain of the small-company Russell 2000 index.
FBR Focus (FBRVX). Last year was an odd one for Chuck Akre, manager of FBR Focus. After the fund (then called FBR Small Cap) reopened to new investors in January 2007, more than $500 million flooded in. "The cash that came in was unexpected and a compliment, but we couldn't find many things that attracted us price-wise," Akre says.
A disciplined value investor, Akre looks for three attributes in companies: a sound business model that generates a return on equity (a measure of profitability) of 15% or higher, quality management and attractive prospects for reinvesting profits. (Low stock value is really a fourth element, but one that is assumed.) Akre's success at generating a 12% annualized gain over the past ten years is evidence that he's uncovering attractive "compounding machines" in which to invest.
After months of keeping his powder dry, Akre is putting his cash to use. "We like it when there's disarray and turmoil in the market," he says. FBR recently purchased a large chunk of CSK Auto, a car-parts retailer, to go with its big stake in O'Reilly Automotive, another parts chain. Akre, who's based in Middleburg, Va., reasons that tough economic times will encourage car owners to extend the life of their vehicles.
Vanguard Selected Value (VASVX). The style-box police would tell you to avoid small-company and midsize-company value funds in today's market. But that's one reason you hire shrewd stock pickers such as Jim Barrow and Mark Giambrone, who run Vanguard Selected Value.
In fact, Barrow says, he's finding some sturdy growers selling at value prices. "Without us changing parameters, we're able to find higher-quality names for the portfolio because growth-company stocks have underperformed," he says. He purchased Avery Dennison, maker of labels the store cashier scans at checkout counters, figuring that its earnings will continue to expand even in a stagnant economy. Dallas-based Barrow is also fond of cigarette stocks -- Reynolds and Carolina -- and holds a funeral-home business and casket maker in the portfolio: With his fingers in both tobacco and death, he's covering his bases.
Julius Baer International Equity II (JETAX). Rudolph-Riad Younes scours the globe with Richard Pell in search of the best investments for Julius Baer International Equity II. This year Younes likes Russia, which is minting money on its rich endowments of oil, gas, gold, nickel and other natural resources. "Almost any commodity known to man is found in huge quantity in Russia," says the New York City-based Younes.
He's also buying Russian consumer stocks because the wealth from commodity exports is percolating down through the economy. "There's been pent-up consumer demand there for 100 years," he says. Younes is similarly keen on Eastern European economies, such as Poland and the Czech Republic, judging that they combine the political stability of developed countries with the high economic growth rates of emerging markets.
Dodge & Cox International Stock (DODFX). Diana Strandberg, one of the nine managers who run Dodge & Cox International Stock, likes the opportunities tossed up in today's stormy markets. "It's a tremendous advantage to have a long-term compass in periods of intense volatility," she says, noting that her shop focuses on a company's earnings three to five years out.
For instance, the fund purchased shares in Unicredito, an Italian bank, because the managers concluded that the stock had been pummeled even though the company had no exposure to the mortgage meltdown in the U.S. Strandberg also likes multinational companies, such as Nokia, Tesco (a U.K.-based supermarket chain) and Lafarge (a big French cement company), that benefit from rising incomes and spending in emerging countries.
T. Rowe Price Emerging Markets (PRMSX). After a long bull run, value ratios in developing markets have caught up to those in the developed world. So emerging-market stocks are no longer cheap. T. Rowe Price Emerging Markets, run by Chris Alderson and his team from London, has been adjusting the portfolio mix. The fund has reduced exposure to countries that depend on exports to a sluggish U.S., such as Taiwan and South Korea. Instead, the fund has boosted its weighting in companies that serve their booming home markets in places such as Russia and the Middle East.
Kinetics Pardigm (WWNPX). One of the most fascinating funds we've come across in years is Kinetics Paradigm. This unconventional, go-anywhere fund is managed by Paul Mampilly, Peter Doyle and Murray Stahl, low-profile iconoclasts with some of the most original minds in the investment business today. Over the past five years, Paradigm, which launched in 1999, has returned an annualized 23%, double the gain of Standard & Poor's 500-stock index.
Mampilly says the portfolio managers consider themselves "classical value" investors. You'll find stocks in Paradigm's portfolio selling at high price-earnings ratios, but these are companies the managers think have the endurance to sustain growth for years to come. As Mampilly puts it: "The value-growth dichotomy is a distinction without a difference."
The fund looks first for companies that sell products or services with long life cycles, enjoy operating stability and have little competition. This initial screen eliminates virtually all tech companies, whose products face the risk of obsolescence. Eligible com-panies must be capable of sustaining a minimum return on equity of 15% for at least three to five years.
After Paradigm's managers conduct a careful business analysis of a company, they often end up investing in pretty much the entire industry. For instance, their investment in the London Stock Exchange provided insight into the favorable forces behind the growth of the world's stock exchanges, which are near-monopolies. So Paradigm bought shares in the exchanges of Hong Kong, Singapore and almost every publicly traded stock market in sight.
In the same vein, they calculated that the reserves of Canadian oil-sands companies were valued at steep discounts relative to those of major international oil companies, so they invested in most of the players in the frozen oil patch of Alberta. Observing rapid consolidation in industrial-metals mining, Paradigm has been snapping up mining shares, which Mampilly says are unfairly priced because many investors view them purely as cyclical companies.
CGM Focus (CGMFX). Ken Heebner had a majestic year in 2007. His CGM Focus soared 80%, outstripping the S&P 500 by an astounding 75 points. From fertilizer producers to iron-ore miners to Russian cell-phone operators, it seemed like Boston-based Heebner deposited every pitch he faced over Fenway Park's Green Monster.
Heebner runs this fund in an utterly idiosyncratic style. Annual portfolio turnover is towering, as is the fund's volatility. But if you fasten your seat belt and don't mind the bumpy ride, you'll probably get where you want to go. Those investors fortunate enough to have stuck with Heebner for the past decade (no easy feat in light of his fund's instability) have seen their money multiply ninefold, or an annualized return of 24%. That's an amazing six times better than the S&P index over the same span.
Marsico Global (MGLBX). It's a big world out there, economies are increasingly interdependent and themes such as the boom in commodities play out globally. Those are some of the reasons for the rise of global funds such as Marsico Global (and the globalization of many "domestic" funds, including CGM Focus, which at last report had about 40% in foreign stocks). "Border-based investment decisions will break down over time," predicts Cory Gilchrist, who runs the fund with firm chief Tom Marsico and Jim Gendelman. "We're looking for the best companies, no matter where they are."
It wasn't much of a leap for Marsico to launch this fund in July 2007. The Denver-based family already ran outstanding growth-oriented domestic and international funds and conducted economic, industry and company research on a global basis. So this is a fund of best ideas (most stocks are picked from other Marsico funds), nearly evenly split between U.S. and foreign-domiciled stocks.
For example, Apple, Las Vegas Sands, MasterCard and McDonald's are four large holdings. All are powerful, U.S.-based companies that book a large chunk of their business overseas. But in oil, the largest holding is Petrobras of Brazil, which, unlike major U.S. oil companies, has been able to boost its reserves dramatically. Nintendo, the Japanese computer-game maker, is a large holding, as is Vestas Wind Systems, of Denmark. You get the idea.
Bridgeway Aggressive Investors 2 (BRAIX). We spoke with John Montgomery, manager of Bridgeway Aggressive Investors 2, after one of the stock market's almost-daily swoons in 2008. Montgomery had no clue whatever about the steep decline, nor did he even seem to care. That's because the MIT-trained engineer manages his fund purely through quantitative models that he plugs into his com-puter. "We never have any feelings about the market," he says. "The great thing about being a 'quant' is that it takes all the emotion out of investing."
Montgomery doesn't disclose much about the secret recipes that dictate buy and sell decisions for the fund. But they clearly work: During the past five years, his fund has returned an annualized 21%.
Fairholme (FAIRX). As a dyed-in-the-wool value investor with a huge cash pile, Bruce Berkowitz is energized by the bargains he's finding in stocks under stress. "Cash is really valuable when no one has it," Berkowitz quips. Fairholme, which he co-manages with Larry Pitkowsky and Keith Trauner, is picking up stocks that have dropped 50% and more from their recent highs.
In the fourth quarter of 2007, the fund purchased a large stake in WellCare, a health maintenance organization hit by a government investigation. And Fairholme invested in bombed-out St. Joe Holdings, the largest owner of undeveloped land in Florida. The state's real estate industry is in a deep recession, but Florida's low taxes, population growth, and abundant water and sunshine make Berkowitz a bull on the peninsula's future.
Berkowitz is also a happy share-holder of cash-rich, acquisitive holding companies, such as Leucadia and Warren Buffett's Berkshire Hathaway. These organizations are "engineered for extremely difficult times," he says, noting that they make ideal lenders and acquirers of last resort. The managers' investing discipline and fine sense of market rhythm underpin Fairholme's excellent performance since its birth in 1999.
Legg Mason Opportunity (LMOPX). Bill Miller, the famed manager of Legg Mason Opportunity, is mired in a slump. "We had a bad 2007, which followed a bad 2006," he recently wrote to shareholders. Miller, who's known for having beaten the market 15 straight years at his larger, more-constrained fund, Legg Mason Value, hints that he's most interested in housing, financials and the consumer sector -- the market's hardest-hit areas. "As long-term investors, we position portfolios for the 95% of the time the economy is growing," he says. Now that's an optimist.
Inflation, that bugaboo of the 1970s and early '80s, is back and may be with us for a while. Over the past year, consumer prices have surged and now the Fed is pursuing an easy-money policy to bail out sick banks and an ailing economy, a stance that may end up stoking inflation even more.
Vanguard Inflation-Protected Securities (VIPSX). There are few ways to protect against inflation, which ravages savings and particularly the value of cash and fixed-income bonds over the long term. For a retiree who depends on income from Treasuries, that doesn't sound too appetizing. For this reason, you might consider investing in a bit of insurance against the corrosive effects of inflation by stashing some of your bond portfolio in Vanguard Inflation-Protected Securities.
Managed by John Hollyer and Ken Volpert, this low-cost fund (annual expense ratio: 0.20%) holds a portfolio of Treasury inflation-protected securities. TIPS are Treasury-issued bonds whose principal value is adjusted monthly to reflect inflation. TIPS are not cheap today, but Volpert, who thinks inflation is on an upward tilt, suggests that investors allocate half of their holdings of Treasuries to TIPS over the long haul.
Bond investors such as Volpert compare the break-even inflation rate implied by fixed-rate Treasuries and TIPS. In mid March, the break-even on ten-year Treasuries was 2.6%. If inflation is higher than that level over the next decade, you're better off in TIPS than in equivalent Treasuries. Volpert says he likes those odds.
Harbor Bond (HABDX). Bond maestro Bill Gross played the market like a fiddle in 2007. He accurately foresaw dramatic interest-rate cuts, so he loaded up on short-maturity Treasuries. He avoided corporate bonds and assets with exposure to toxic subprime mortgages. He made some canny bets on emerging-markets bonds and currencies. The result is that Harbor Bond, which Gross's Pimco manages, has gained 9% over the past year, nearly three percentage points better than the Merrill Lynch U.S. Broad Market index.
Dodge & Cox Income (DODIX). Dodge & Cox Income stayed out of trouble, too. It did so by avoiding direct exposure to subprime lending and by sticking principally with the bonds of stable, strong businesses that have good cash flows and with mortgage securities backed by government agencies such as Fannie Mae. Dana Emery, a member of the nine-manager team running the fund, says the group is finding plenty of opportunities in corporate bonds -- including many issued by financially solid companies -- because they yield significantly more than Treasuries.
Loomis Sayles Bond (LSBRX). The breadth and depth of Dan Fuss's knowledge and experience are on full display as he swiftly surveys the global picture. He's avoiding debt denominated in the euro and the yen because of looming trouble with banks in Europe and Japan (among other reasons). He likes debt from Canada because of the nation's fully financed retirement program and success at boosting oil output. In the U.S., he thinks the budget deficit will rapidly snowball, but he's finding value in investment-grade industrial bonds. Fuss's mastery is the chief reason that Loomis Sayles Bond, which he co-manages with Kathleen Gaffney, has returned an impressive 9% annualized since its inception 11 years ago.
Fidelity Intermediate Municipal Income (FLTMX). The normally placid world of municipal bonds has become a lively scene. Last summer, long-term munis paid little more than short-term tax-free bonds, and spreads between high-quality and low-grade credits were remarkably narrow. Then some tremors began shaking bond markets. "Within a month, the world had changed," says Mark Sommer, portfolio manager of Fidelity Intermediate Municipal Income. The markets got really wild in the muni patch when investors began to question the financial health of the big insurers of muni bonds.
Sommer spies opportunity. "We're trying to take advantage of irrational prices on insured bonds," he says. "Some of these bonds are being penalized by investors who don't understand underlying credit quality." Backed by Fidelity's crack team of bond analysts, Sommer should have an interesting year.
Pimco CommodityRealReturn Strategy (PCRCX). If fear of inflation keeps you awake at night -- or even if it doesn't -- consider investing in commodities through Pimco CommodityRealReturn Strategy. This ingenious fund provides two layers of inflation protection. Manager Mihir Worah acquires exposure to the unmanaged Dow Jones-AIG Commodity index through structured notes, a kind of derivative in the form of a debt obligation. He fully collateralizes those positions with an actively managed portfolio of TIPS (the fund employs no leverage).
Commodities are a volatile asset class, but they hold their own against inflation and, more important, their movements are totally out of sync with those of stocks and bonds. Therefore, commodities add diversification to a portfolio, increasing the expected return and decreasing the expected risk. But you should invest in commodities for at least three to five years.
The DJ-AIG index holds a basket of 20 commodities, including oil, gasoline, heating oil, natural gas, industrial and precious metals, grains, soft commodities, and livestock. The Pimco fund has returned an annualized 21% since its inception in June 2002. That includes a ridiculous 23% gain in the first ten weeks of 2008, which suggests that commodity prices may be over-extended in the short term. The Pimco fund's Class D shares are available without a sales charge through many discount brokers.