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Can a Stumbling Clipper Regain Its Stride?

A close look at Morningstar's only 1-star Analyst Pick.

Dan Culloton, Associate Director of Fund Analysis, 04/19/2011

Clipper CFIMX managers Chris Davis and Ken Feinberg are on the hot seat.

From the managers' Jan. 1, 2006 start at Clipper through April 12, 2011, the fund lost 0.38% annualized, while the S&P 500 gained 3.13% and the typical large-blend fund advanced 2.75%. The fund has done better since the March 9, 2009, bottom of the bear market, rising nearly 48% annualized through April 12, more than 8 percentage points better than the S&P 500 Index and nearly 10 percentage points better than the large-blend category.

Still, the fund is now Morningstar's only Analyst Pick with a 1-star rating, and many wonder which is the real Clipper--the crashing one or rallying one. Davis and Feinberg's track record since 1994 at Davis New York Venture NYVTX suggests the rallying one, but let's dig in.

Once Bitten, Twice Shy?
An investor who has suffered a setback must still be willing and able to invest with conviction to dig out of his or her hole. A skilled manager who becomes indecisive or timid after a rough patch can end up fighting the last war, which is "a sure way out the door," at Davis Selected Advisors, Davis said recently.

Don't show Davis and Feinberg the door, yet. This is still a high-conviction fund. It has just 24 holdings and 72% of its assets in its top 10, including more than a fifth of its money in its two largest positions, which at the end of March 2011 were Costco Wholesale COST and Canadian Natural Resources CNQ.

The duo also remains committed to its process. Davis and Feinberg aim to buy and hold the shares of good companies at discounts to their true earnings power and sometimes pay up for leading franchises with strong long-term growth prospects. Costco, for example, has one of the highest forward price/earnings ratios in the portfolio, yet it remained at the top of the fund's list at the end of the first quarter because it dominates the warehouse-club segment of the retail sector and is poised to take market share from other discounters and grow internationally.

Running to Stand Still?
Concentration alone doesn't prove conviction, though. Managers show how much they believe in their processes by sticking with them even after they serve up some stinkers. Davis and Feinberg kept the faith after their 2008 drubbing. Even as they were licking their wounds from American International Group AIG and Merrill Lynch, the managers bought Goldman Sachs GS when it was trading below its book value in 2008 and early 2009. That was consistent with Davis and Feinberg's long-stated preference for dominant businesses at attractive prices. So were the fund's purchases of CVS Caremark CVS, Diageo DEO, Coca-Cola KO, and Wells Fargo WFC during roughly the same time period.

In the past year, the fund sold J.P. Morgan Chase JPM, but not because Davis and Feinberg thought it was no longer a premier bank. They grew wary of the institution's large, opaque derivative exposure and new government regulations that targeted major revenue sources, such as credit cards. The managers decided there were enough unknowns to warrant getting out as the stock recovered. The fund also recently sold Coca-Cola after nearly two years of strong gains.

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