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Investing

New Life for Broken Funds

A company will throw everything it's got to turn around a big laggard that hurts its bottom line.

Big mutual funds are the breadwinners of the fund industry. They are wonderfully profitable for fund companies. However, sometimes things go bad and a big fund isn't so profitable for the folks who actually invest in it. Problems such as asset bloat, departing managers and plain old poor stock selection undermine quite a few big funds every year. When that happens, a fund company suffers a double whammy: Investors pull money out of the lagging fund, and they're reluctant to invest in even the company's better-performing funds. The good news is that a fund company will throw everything it's got to turn around a big laggard because that laggard hurts its bottom line.

Back from the dead?

Some prominent funds that suffered extended slumps are at last showing signs of life. The key to deciding whether to hold on is whether the fundamental problems have been fixed. If they have, then stay put. If it was just a lucky year, you should probably bail. (Total returns below are for the first five months of 2007.)

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Fidelity Magellan (symbol FMAGX) is proof that giant funds can suffer long slumps. The fund was a dud for a full decade even though Fidelity desperately wanted its flagship to succeed. Now, Harry Lange finally has Magellan heading in the right direction. In Lange's 21 months at the helm, he has remade Magellan into a much more aggressive growth fund that looks a lot like his old fund, Fidelity Capital Appreciation. Magellan is up 11% in 2007, versus 9% for Standard & Poor's 500-stock index. At $44 billion in assets, Magellan is smaller than it's been in more than a decade, even as the market's overall value has grown substantially -- meaning that the fund is probably more agile than it's been since Peter Lynch retired in 1990. If you own Magellan, you should probably stay with it and see where Lange takes it.

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American Century Select (AASLX) also boasts a nice 11% gain in 2007, although its returns for the past three- and five-year periods are dismal. I'm not sold on Select because the architect of its rebound, Harold Bradley, left American Century in January -- just ten months after taking the helm. Although Michael Li and Keith Lee will continue with the fund's revamped strategy, it's tough to get excited when you consider that they were on board for some bad years, too.

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Go ahead and throw the old record of Dreyfus fund (DREVX) out the window. Dreyfus moved the funds it had managed directly to firms owned by parent company Mellon, and Dreyfus was handed over to Sean Fitzgibbon, of Boston Company Asset Management, in 2005 -- a big upgrade in management. The fund is up 9% for 2007, and it's up 23% for the past 12 months. In addition, Fitzgibbon has a strong record at Boston Company Large Cap Core (SDEQX), which he has run since 2003. The strategy is a conservative focus on blue-chip stocks. If the big end of the market takes off, so will Dreyfus.

Nothing to fix here

One underperformer I wouldn't want to remake is Longleaf Partners International (LLINX). The fund suffered three years of severely subpar returns, from 2004 through 2006, mainly because Longleaf hedges its currency exposure and a falling dollar was responsible for big gains in competitors' funds. Currency moves tend to reverse at some point, however, and this fund should do fine when that happens. In fact, it's already up 15% this year despite the dollar's weakness. Staley Cates and Mason Hawkins have produced great long-term returns at Longleaf Partners and Longleaf Partners Small-Cap by running a focused portfolio of super-cheap stocks bought at a discount of 40% or more to the managers' intrinsic-value estimates. My only suggestion: Cut the fund's 1.61% expense ratio.

Columnist Russel Kinnel is director of mutual fund research for Morningstar and editor of its monthly FundInvestor newsletter.

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