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Will These Fallen Heroes Ride Again?

Bet on the jockey, not the horse.

Russel Kinnel, 10/19/2010

Deciding whether to buy or keep a fund that was once a top performer can be tricky. Besides all the normal factors to consider, you may have to sort through some emotional baggage. If the fund made you money in the past, you may be biased toward it even though it may be under new management and look much different from it once did.

In the best cases, star funds remain stars--if not forever, at least for decades. Among funds in that small category are American Funds Growth Fund of America AGTHX, Fidelity Contrafund FCNTX, T. Rowe Price Equity Income PRFDX, Loomis Sayles Bond LSBRX, and Vanguard Wellington VWELX.

But many other onetime luminaries have sagged, lagged, or gagged because their management or strategies changed.

The Cooking Test
Before I'll consider buying into a blast from the past, a fund must pass two tests. First, the current manager must hold a significant stake in his or her fund. If a manager doesn't have the conviction to invest at least $1 million in his fund, I'm not buying.

Managers' reluctance to eat their own cooking disqualifies some high-profile funds. Neither of American Century Ultra TWCUX's managers, Keith Lee and Michael Li, has more than $50,000 in the fund, so it's out. Harry Lange has only between $500,000 and $1 million in Fidelity Magellan FMAGX five years after taking the helm, so Magellan's out, too. Ditto for John Roth at Fidelity New Millennium FMILX and James Mordy at Vanguard Windsor VWNDX--both have chalked up good numbers but haven't yet crossed the $1 million investment threshold.

The second test is that current managers must have outperformed their benchmark--not necessarily by a huge amount--since taking over the fund. Running a big, prominent fund is a challenge, and I want to know that the manager can succeed in making the jump from managing, say, $1 billion to running $10 billion. Ultra and Magellan fail this test, too.
Fidelity Dividend Growth FDGFX is another former winner that deserves a close look. Larry Rakers has just two years at its helm, but he performed brilliantly at Fidelity Balanced FBALX, which held about the same amount in stocks as Fidelity Dividend Growth FDGFX's total assets. So there's little question that Rakers can handle the added girth.

The fund languished under the previous manager, Charles Mangum, who favored stocks of huge companies. Rakers, by contrast, invests in companies of all sizes. In 2009, his first full year as manager of Dividend Growth, the fund sizzled, gaining 51%. Despite this and Rakers' fine long-term record, investors are not rushing to pour money into Dividend Growth. That's one perk of buying fallen angels that have been scrubbed off investors' lists. They're unlikely to drown in a flood of new cash anytime soon.

Janus Overseas JAOSX passes both tests. I know, I know. The very name Janus makes some people recoil because of past indiscretions and disastrous performance at some of its funds after the collapse of the technology bubble in the early 2000s. But the folks responsible for Janus' involvement in the market-timing scandal are gone, as are most of those who stank in the 2000-02 bear market. This fund hasn't actually had the extended run of poor performance that the other funds I mentioned have, though it did relatively poorly in the earlier bear market. Still, I think it's worth including given the downdraft that Janus as a whole suffered in 2000-2002.

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