A Bad Year for a Great Fund

What do you get when you assemble an all-star cast of money managers and ask them to each run a piece of a mutual fund? Presumably, you get a fund that will deliver stellar returns -- at least over the long run. But what happens when several of those managers turn as cold as icicles at the same time? In that case, you have the recipe for a terrible year.

This scenario describes what has happened this year to Masters' Select Equity, which is run by managers from six highly regarded outfits. Each manager (or pair of managers) contributes five to 15 of his best stock ideas to the portfolio. Sounds like a formula that can't miss, right? Alas, the formula isn't working well in 2006. Year to date through Wednesday, the fund was down 4.3% and was trailing Standard Poor's 500-stock index by more than nine percentage points.

Masters' Select Equity (symbol MSEFX) gives investors access to top-shelf talent. Chris Davis and Ken Feinberg of Selected American Shares invest 20% of the fund's assets, mostly in large-company stocks. Ditto for Craig Blum and Stephen Burlingame of TCW Select Equities. Bill Miller of Legg Mason Value and Mason Hawkins of Longleaf Partners also invest 20% of assets apiece. They invest in companies of any size. Dick Weiss of Wells Fargo Advantage Common Stock and Bill D'Alonzo of Brandywine each fill 10% of the portfolio with small- and midsize-company stocks.

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Miller, who is having a terrible year (and whose string of 15 straight years of market-beating performance is in grave jeopardy), is a major culprit in Select Equity's performance. In particular, his fondness for Internet stocks -- the fund holds Amazon.com, eBay, Expedia and Yahoo, all Miller picks -- has hurt Select Equity. Amazon, which as of June 30 was the fund's second biggest holding, at 3.8% of assets, was also a top choice of the Blum-Burlingame team. Their TCW Select Equities has lost 12.5% so far this year.

Ken Gregory and Jeremy DeGroot pick the managers for Select Equity and the other Masters' funds. In the past, they have dropped managers who failed to perform. But Miller, Blum and Burlingame are not on the chopping block, says DeGroot, who is also a columnist for Kiplinger's Personal Finance. "These managers have long investment horizons," he says. "They are not the type of managers who sell in the short-term and try to jump back in at a better time."

It would be hard to dump Miller, given his remarkable streak. But hanging on to Blum and Burlingame is tougher to defend. They took over TCW Select Equities in 2004 after the fund's longtime manager, Glen Bickerstaff, stepped down. Since then, the duo have had one good year, one so-so year and one awful year. But DeGroot defends the decision to retain them: "We would not have kept Blum and Burlingame on the fund if we didn't think they are great stock pickers, totally embedded in Bickerstaff's investment philosophy." Bickerstaff himself recently told investors that Select Equity's portfolio would be no different if he was still lead manager.

Don't fault Select Equity for one bad year. The fund trailed the market in 1997 and 1998, but since then it has outperformed the SP 500 every year -- until this one. The Masters' concept of assembling some of the very best managers at one fund makes a lot of sense. But investors need to be aware -- and this year's numbers certainly bring the point home -- that even great investors can have bad years.