How to employ our Fund Manager of the Decade nominees wisely.
So, now that we've named our nominees for Fund Manager of the Decade, are you thinking about adding one or more of their funds to your portfolio? If you're sitting with a collection of mediocre funds right now and wouldn't incur onerous tax burdens by overhauling your portfolio, that could be a good idea--heck, we wouldn't have made these managers nominees for our award if we didn't think so.
But you should mind certain risks and idiosyncrasies of these funds. Both advisors and individual investors are often guilty of expecting too much out of their investments. Having reasonable expectations is perhaps the best bulwark against bad investor behavior, such as giving up on a fund at the worst moment. What follows is an effort to set rational expectations for our domestic-equity Manager of the Decade nominees' funds and to help you use them wisely.
Expect Style Drift
First, if you like organizing your portfolio strictly around the Morningstar Style Box so that you know exactly how much large-cap and small-cap exposure you have at all times, almost all of our domestic equity nominees will give you fits. You may consider avoiding most of them altogether or only using them on the margins of your portfolio.
For example, Fairholme
Over the past decade, Fairholme has found itself in the mid-blend and large-growth boxes, while Yacktman landed in the mid-value box a decade ago when large caps were arguably much more expensive than they are now. Yacktman has been in the large-blend box, too.
Steve Romick's FPA Crescent
Fidelity Low-Priced Stock
Only Charlie Dreifus at Royce Special Equity
Expect Meaningful Sector Bets
Royce Special Equity may not move around the style box much, but its sector and industry weightings will differ markedly from those of its peers. For example, Dreifus may never own a bank or a real estate investment trust, which are included in most small-cap indexes. Dreifus avoids debt like the plague, and banks and REITs typically carry a lot of debt. So, Royce Special Equity will look and perform differently than its small-value peers, most of which stick close to small-cap indexes, financials and all. Not holding banks and REITs made the fund look sluggish versus its peers from 2003 through 2005, and it could underperform again if debt-heavy companies become darlings again. This is no reason not to own the fund, but understanding this can help you hold it through what seem to be difficult times.
Fairholme's sector bets also stand out. It currently has around 36% of its assets in health care, including bets on pharmaceutical giant Pfizer
Berkowitz's health-care wager hasn't hurt the fund, but he almost certainly will get some of his bets wrong at some point. Nobody's perfect in investing; even Warren Buffett has made bad bets on airlines in the past. The point is that you have to be confident that you can own Fairholme over the long haul and endure a bad bet or two along the way if you're going to use this fund well.
None of the funds on our list is an index-hugger, which partly is what has made them so good over the years. If you're going to pay for active management, you may as well get it. These funds certainly give it to you in spades. The qualities that have made them so good over the longer haul, however, can also make them sputter in the short term and make you question why you own them. Knowing how these funds operate can help you hang on during the tough times and ultimately use them to your advantage.
John Coumarianos is a mutual fund analyst with Morningstar.
Get mutual fund and stock information from our analyst team delivered to your e-mail inbox every Tuesday. Sign up for our free Investment Insights e-newsletter.