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Fine Fund, Lousy Year

Was a horrific 2008 boringly predictable or a preview of coming disasters?

Shannon Zimmerman, 01/26/2012

The past isn't always prologue, but that turns out to be the case often enough that investors can benefit from paying close attention to it. With the third anniversary of the market's March 2009 nadir approaching, I'm gauging whether the managers of the funds I follow have learned from their mistakes. In certain cases, I'm also assessing whether they made any.

For an upcoming issue of Morningstar FundInvestor, I'm researching the current and historical financial-health profiles of the U.S. stock funds that fared the worst during the market's 2007-09 downturn. Among other things, I'm reviewing the pre- and post-crisis portfolio data for these funds to determine if their managers have altered their approaches and, if so, how the composition of their portfolios has changed.

For the subset of domestic-equity managers who own solid long-term track records but fared miserably in 2008, I'm researching the extent to which that year's poor performance owes to unforced errors. That is, gauged relative to their investment processes rather than 2008 returns, did these managers make moves inconsistent with, and riskier than, those that usually result from their strategies?

On that front, one fund that continues to be a focus of my research is Fidelity Leveraged Company Stock FLVCX.

Test Case
Ranking among 2008's biggest disasters, the fund shed nearly 60% of its value during that year and landed in the mid-cap blend category's 98th percentile. Painful though that dramatic drop was, horrible performance during a downturn resulting primarily from frozen credit markets shouldn't have surprised anyone familiar with the fund's name.

As its handle suggests, the fund's manager, Tom Soviero, favors firms whose attractive valuations owe in part to the discount the market has applied to their less-than-pristine balance sheets. Whenever credit markets tighten, let alone seize up as they did in 2008, shareholders in the fund should anticipate that it will suffer, perhaps mightily.

Still, even in light of the fund's name, its mandate, and its manager's aggressive style and background as a high-yield credit researcher, should shareholders have anticipated a 2008 nosedive of almost 60%? At a glance, at least, the fund's historical portfolio data suggests that one good answer is…

You have to squint a bit to see it, but the 2008 portfolio data do suggest that at least some investors might have been head-faked by a seemingly temperate list of holdings relative to the fund's nervy (and sometimes nerve-wracking) investment approach.

Shannon Zimmerman is an associate director of fund analysis at Morningstar.
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