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Experienced Manager, Svelte Fund: A Winning Formula?

The advantage usually goes to the small fry when it comes to fund returns.

Christine Benz, 07/24/2007

At the Morningstar Investment Conference in late June, a conference attendee asked Ken Feinberg whether investors are better off buying Selected American SLADX or Clipper Fund CFIMX, both of which he comanages with Chris Davis. "Clipper," Feinberg replied, "because it's smaller."

Few managers are quite as candid as Feinberg when it comes to assessing whether size makes a difference in their funds' performance. And we'd acknowledge that it's impossible to set hard-and-fast guidelines about how big is too big when it comes to fund size. For example, American Funds Growth Fund of America AGTHX, with $184 billion (!) in assets, would seem to be exhibit A in any discussion of bloated funds. However, the firm's multimanager structure has bought it a bit more breathing room than a single-manager fund would enjoy, and performance has continued to thrive. Similarly, Davis and Feinberg's low-turnover approach has helped their funds grow large more gracefully than higher-turnover funds could do.

All things being equal, however, it's hard to dispute that it's easier to run a small fund than a big one. That's why we've often called for bloated funds to close. For proof, one need look no further than fund pairs--one large, one smaller--run by the same manager. Although the timing of cash flows and strategic differences account for some of the performance differential, in most cases the smaller fund's performance has trumped that of its larger relative. Here are some prominent examples.

Manager: Will Danoff
Best-Known Fund: Fidelity Contrafund
Lesser-Known Fund: Fidelity Advisor New Insights FNIAX
Neither of Will Danoff's charges is a slouch, and neither is especially small, for that matter. But Advisor New Insights, launched four years ago, has beaten its bigger, better-known sibling by nearly 3 percentage points per annum since its inception. Danoff took advantage of New Insights' small size earlier in its life to take larger positions in his highest-conviction picks than he could reasonably take in Contra, and that tack paid off from 2003 through 2005. More recently, the two funds have moved closer together, both in terms of their portfolios and their performance. That's likely because New Insights, with $8 billion in assets, is itself one of the 25 largest large-growth funds and doesn't afford Danoff the same maneuverability he once had. Both funds are closed to new investors.

Manager: Bill Miller
Best-Known Fund: Legg Mason Value
Lesser-Known Fund: Legg Mason Opportunity LMOPX
It would be a mistake to suggest that Bill Miller's smaller fund, Opportunity, is simply a nimble alternative to Legg Mason Value. It's not. Whereas Value Trust is a long-only portfolio, Opportunity was designed as "Bill Miller Unplugged": a go-anywhere offering that allows him to use derivatives and take short positions. Thus, we're not too surprised by these funds' divergent performance patterns. It's worth noting, however, that Opportunity has consistently had the upper hand, besting Value Trust in each year since the former fund's launch in 2000. Unlike Danoff, Miller is still running his portfolios with meaningfully different approaches, even though Opportunity Trust is a far-from-svelte $8 billion. While both portfolios feature longtime Miller favorites such as Amazon.com AMZN and Sprint Nextel S, Opportunity Trust skews more toward mid-cap names and has a milewide opportunistic streak. (A recent and successful bet on steelmakers is a case in point.) That eclecticism has ratcheted up volatility at Opportunity Trust, but for our money, it's the better play on Miller's best ideas.PAGEBREAK

Manager: Scott Schoelzel
Best-Known Fund: Janus Twenty
Lesser-Known Funds: Janus Adviser Forty JDCAX, Janus Aspen Forty JACAX
Most retail Janus funds have similarly managed counterparts in the advisor (Janus Adviser funds) and variable insurance/institutional channel (Janus Aspen funds). And in most cases, performance is pretty close. Scott Schoelzel's charges, however, showed some of the biggest return differentials: Both of the Forties have beaten Twenty by an average of 2 percentage points per year over the past decade. The return difference owes in part to strategy differences. As the funds' names make plain, Adviser Forty and Aspen Forty have at times featured more-diffuse portfolios than Janus Twenty. (Not so these days: All three portfolios hold 37 stocks.) However, Twenty's size--it was one of the largest concentrated funds in the late 1990s--undoubtedly exacerbated its bear-market losses and explains part of the performance difference. Although Twenty is closed to new investors, we'd recommend hanging on to it, because we think Schoelzel is a talented stock-picker and isn't likely to confront the huge asset inflows he faced in the late 1990s.

Managers: Chris Davis and Ken Feinberg
Best-Known Funds: Selected American,
SLADX Davis New York Venture NYVTX
Lesser-Known Fund: Clipper Fund CFIMX
Although the preceding examples showcase how smaller funds have been able to scoot past their larger siblings, Clipper Fund has lagged Selected American and Davis New York Venture since the Davis/Feinberg team took it over at the beginning of 2006. As with Schoelzel's funds, strategy differences are probably more the story than asset size. Clipper is more concentrated than the pair's other charges--holding roughly double the percentage in its top 10 holdings as the Selected and Davis funds--and some of its top-weighted holdings, such as American International Group AIG and Harley-Davidson HOG, have struggled. Even so, we think Clipper's prospects are bright, particularly because the fund's expenses have come down substantially under the new regime.

Christine Benz is Morningstar's director of fund analysis.

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