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Fund Times: LBO Frenzy Boosts Fund Returns

Plus, news on new Turner funds, Causeway's emerging-markets fund, and more.

Morningstar Analysts, 11/27/2006

The recently announced buyouts of copper producer Phelps Dodge PD and REIT giant Equity Office Properties Trust EOP have helped out a few funds, as leveraged buyouts can have a dramatic impact on a firm's stock price and, thus, on fund returns.

The day Freeport-McMoRan bid for Phelps Dodge the stock rose nearly 30%, and Equity Office Properties saw a 7% increase after the Blackstone Group made its offer. Funds that benefited from the Phelps deal include Brandywine Fund BRWIX and Fairholme Fund FAIRX, which both had sizable positions in Phelps Dodge prior to the buyout being announced. So did Jennison Natural Resources PGNAX and Neuberger Berman Partners NPRTX. Predictably, funds that have benefited from the more modest stock price move at Equity Office include real-estate-oriented funds, such as Fidelity Real Estate Investment FRESX and Cohen & Steers Realty Shares CSRSX.

While buyouts can often be good news for equity funds, they are typically bad for bondholders. This is because the additional leverage used to finance the deal can impair the company's ability to repay its obligations. Additionally, the credit quality of the company can deteriorate, resulting in higher borrowing costs. In the case of Equity Office Properties, however, certain bondholders should do okay. Protective covenants embedded in the bonds held by Standish Mellon Fixed-Income SDFIX, for instance, should protect them here. Manager Cathy Powers of Standish Mellon has been sensibly shifting into REIT bonds in her fund's portfolio to protect it from this LBO risk.

Turner Files for Two New Funds
Turner Investment Partners has filed with the SEC to offer two new mutual funds, Turner International Core Growth and Turner Midcap Equity. The International fund, which will only be offered in an institutional share class, will be run by Mark Turner, Christopher McHugh, and Robert Turner. The fund will primarily invest in the stock of international firms with market caps larger than $2 billion, which management believes will see improving earnings growth. Both Mark and Robert Turner run Turner Core Growth I TTMEX and other portfolios that have achieved respectable records in the large-growth category, partly due to modest investments in foreign firms.

McHugh works as the lead manager on Turner Midcap Growth TMGFX and as a comanager of Turner Small Cap Growth TSCEX. He has also contributed to the firm's research work on the telecommunications industry. The fund will initially charge a 1.1% expense ratio. While this will be the advisor's first foray into the international arena with an open-end fund, the firm has run similar institutional accounts in the past.

Turner Midcap Equity will be managed by the same team that runs Turner Small Cap Equity TSEIX, Thomas DiBella and Kenneth Gainey. While the team has plenty of experience investing in mid-caps (nearly a fourth of the Small Cap portfolio currently resides in mid-cap territory), Small Cap Equity's record gives us pause, as the fund has lagged its category peers for much of its short history.

Causeway to Launch New Emerging-Markets Fund
Causeway Capital Management has announced its plans to launch Causeway Emerging Markets, a quantitatively oriented fund run by Arjun Jayaraman and Macduff Kuhnert. The fund will typically keep at least 80% of its assets in emerging-markets securities, and the quantitative model will use various fundamental, technical, and macroeconomic factors in selecting stocks.PAGEBREAK

While we'll wait and see exactly how the quantitative approach functions, we're encouraged here by the advisor's success with one of its other funds, Causeway International Value CIVVX, and by its history of strong fiduciary responsibility to shareholders. For instance, at International Value (a nonquantitative fund), the firm began taking steps to control asset growth in the fall of 2004 and closed both the retail and institutional share classes of the fund to new investors in February 2005 in order to preserve capacity and the managers' ability to follow their discipline.

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