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Kip 25

Should You Buy BBH Core Select Before It Closes?

This Kiplinger 25 fund will soon shut its doors to new investors. Before it does, consider taking a starter stake.

At their worst, pre-announced closings of mutual funds can take on the odor of going-out-of-business sales at rug merchants. I don't think that's the case, however, with BBH Core Select (symbol BBTEX), which plans to close to new investors after assets reach $3.5 billion, $200 million more than the fund currently holds.

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Investors, not surprisingly, are beating a path to the fund's door because it has produced superb results. Over the past five years through October 18, BBH Core Select returned an annualized 6.7%. That puts it in the top 1% of large-company blend funds and beats Standard & Poor's 500-stock index by an average of 5.6 percentage points per year. What's more, BBH Core Select produced those sterling numbers while exhibiting 20% less volatility than the S&P 500.

In short, this is a fund that has turned in great results with relatively low risk -- the best of all possible worlds in investing. Co-managers Timothy Hartch, Michael Keller and Richard Witmer have produced such good returns by implementing a disciplined and patient investment process.

The three managers and nine analysts first screen for companies with low debt, high free-cash flow and high returns on invested capital (a measure of profitability). Next they apply equally stringent qualitative screens. They seek companies that are leaders in growing industries, that sell essential products and services to a loyal customer base, that boast competitive advantages, and that are run by ethical managers who own a substantial amount of stock in the company and are good at allocating capital.

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That leaves the BBH team with roughly 160 companies. From those, the managers pick 25 to 30 that are selling at the healthiest discounts to the managers' estimates of the companies' fair value. The fund's biggest sector weightings currently are financial services (23%), consumer staples (22%) and health care (16%). About 17% of assets are in foreign stocks, and 9% is in cash.

Most of the companies the BBH managers gravitate toward look solid to me. Their largest holdings include Warren Buffett's Berkshire Hathaway (BRK.A), Swiss food giant Nestlé (NSGRY.PK), Google (GOOG) and drug maker Novartis (NVS), also based in Switzerland. Of course, that doesn't mean their stock prices are immune from selloffs. Google plunged 8% on October 18, but Hartch expressed confidence in the stock after the market closed that day.

BBH's managers don't trade often -- even when one of their stocks plunges. Last year's turnover was just 17%, suggesting that they hold stocks for more than five years, on average.

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The fund isn't without question marks, however. It adopted its current strategy in 2005, when Hartch and Witmer came on board. Keller joined in 2008. All three managers had years of experience at Brown Brothers Harriman, sponsor of the BBH funds.

So you only have about seven years of returns to judge the fund's mettle. I'd prefer a longer track record. But those seven years included the 2007-09 bear market, when BBH Core Select did much better than its peers, losing only 41.1%, compared with a 55.3% loss for the S&P and a 61.0% descent for the average large blend fund.

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Hartch credits those relatively good returns largely to superior stock selection in financial services. The fund steered away from the major Wall Street banks and other financial firms that blew up during the crisis. "We didn't anticipate the crisis," he says. But the fund's financial-services analyst did believe that some of the banks were taking on too much risk. Moreover, Hartch says, the fund gravitates toward companies with business models that are simpler than those of the big banks.

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Was 2007-09 a fluke for BBH? I don't think so, but we won't know for sure until the fund goes through another big downturn or two.

Core Select is, unquestionably, built to lag in straight-ahead bull markets. So far this year (through October 18), it has gained 20.0%, putting it in the top 9% of its peer group and beating the S&P 500 by 2.1 percentage points. But I view this year's performance as an anomaly. The fund trailed its peers and the S&P in the strong markets of 2006 and 2009.

But I'm a whole lot less worried about lagging in a bull market than about how a fund will do in the next bear market. If you are, too, this fund is worth considering. It will likely close by the end of this month. The store really is closing.

Steven T. Goldberg is an investment adviser in the Washington, D.C. area. He and a few of his clients own shares of Berkshire and Novartis.

Kiplinger's Investing for Income will help you maximize your cash yield under any economic conditions. Subscribe now!

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