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Evaluating 3 Big Mutual Fund Handoffs

Should you stay or should you go?

Russel Kinnel, 08/23/2012

This article originally appeared in Morningstar FundInvestor.

Some of the trickiest handoffs in the fund world happen at the retirement of renowned managers who run idiosyncratic strategies that are a manifestation of their personalities. Not only are the successors filling big shoes, but they also have to decide how much they want to change the strategy in light of investors' expectations. After all, investors didn't come to Third Avenue Value TAVFX,
First Eagle Global SGENX, or Columbia Value & Restructuring UMBIX for plain vanilla.

As fund investors, we must be particularly alert to changes at such funds while at the same time assessing the abilities of the managers and analysts in charge. Quirky strategies make for quirky returns, and it takes a longer time period to really judge them. Look back over their histories and you'll see these funds have gone in and out of favor a few times even though their long-term returns look appealing.

In June, I moderated a panel of managers running three funds that had recently made the switch. I felt our Analyst Ratings for the funds were validated by what I heard, but with the funds in transition, those ratings are hardly carved in stone.

First Eagle Overseas SGOVX and Global SGENX
I imagine investors feel the best about these two because the record under current management is the longest and it has also been pretty good. Jean-Marie Eveillard and Charles de Vaulx did a brilliant job of protecting against losses while still producing strong long-term returns, and the funds have continued to perform in a fashion you'd expect. They lost less than most in 2008 and 2011, and five-year returns are top quartile for both funds. The five-year return is probably the best one to use here as comanager Abhay Deshpande's tenure dates to September 2007. Matthew McLennan was named comanager on Sept. 12, 2008, and Kimball Brooker became comanager in March 2010. You could also argue that the three-year record is most telling because Eveillard retired in March 2009.

Both boast solid three-year records, too, although Global's is a bit stronger. More importantly, the strategy guiding the funds doesn't seem to have changed. Deshpande worked for years with Eveillard, and McLennan was brought in because he seemed a good fit with the strategy. So you have funds focused on capital preservation that will hold cash, bonds, and gold alongside an array of global value stocks. The chief difference is that Global has about 34% of assets in United States stocks, while Overseas owns virtually no U.S. stocks. As a result, Overseas' recent returns are a bit behind Global's. The fund's have kept the strategy intact, so I'll just watch to see how well they execute.

Third Avenue Value TAVFX
After the panel, the first question I fielded was why, given its poor three-year numbers, Third Avenue Value received an Analyst Rating of Silver. (By mid-August the year-to-date performance was actually quite strong, three-year figures less so.) For starters, Third Avenue has built a strong stable of analysts and managers, each of whom apply Marty Whitman's "safe and cheap" mantra. Lapey has worked at Third Avenue for more than a decade and was named comanager in July 2009. Whitman handed him the keys in March 2012 when he stepped down from the fund (but not from the firm).

Although Lapey says he plans to continue using Whitman's strategy, he quickly went to work on the fund's biggest vulnerability, paring a huge weighting in Hong Kong real estate names to 39% of assets from 50%. This makes sense, as defensiveness was one of the fund's appealing traits for many years. Even if Hong Kong real estate names do well, the bet is outsized and not really consistent with "safe and cheap" from a portfolio perspective. Ten years ago the fund had 30% of assets in its top 10 holdings. That concentration hovered between the 30s and low 40s before the Hong Kong bet swelled assets in the fund's top 10 to as high as 71% in 2010.

The dialed-down bet is a welcome change, and we believe the fund still has potential. Lapey is a thoughtful value investor who isn't likely to follow crowds, but he has his work cut out for him. Some shareholders are losing patience, with the fund seeing $700 million in outflows so far this year.

Columbia Value & Restructuring UMBIX
Guy Pope, who took over Value & Restructuring in May 2012, has built a good record at Columbia Contrarian Core LCCAX, where he has thumped the S&P 500 since 2005 with a cumulative 66% gain versus 39% for the index from March 2005 through July 2012. We rate Contrarian Bronze, but Value & Restructuring has received a rating of Neutral because we don't have a record for the new strategy Pope will apply here: He aims to split the difference between his more growth-oriented Contrarian Core strategy and Value & Restructuring's value-leaning strategy.


Moreover, there doesn't appear to be much DNA left from retiring manager David Williams. Pope is based in Portland, Ore., and runs funds with a team of four, while Williams largely worked on his own in Florida. It's a very different situation from Third Avenue and First Eagle, where the managers were groomed by their predecessors to invest in a similar fashion.

Prior to the May handover, the two funds had no top-10 holdings in common, and it's hard to imagine Williams going for Apple AAPL, eBay EBAY, or Google GOOG, which are in the top five of Contrarian Core. Both funds are in our large-blend category  but Value & Restructuring leaned to the value side with a smallish $21 billion median market cap compared with $70 billion for Contrarian Core.

In addition, Contrarian Core ran a 79% turnover rate in 2011, while Value & Restructuring ran 9% turnover. Pope said he and comanager J. Nicholas Smith have a rule that they will trim a position that lagged the benchmark by 15% and review the stock to see whether it still belongs in the portfolio. Thus, they appear to be less patient than Williams.

So we have a good manager, but we don't know whether this fund will turn into a Contrarian Core clone or something with lower turnover and more value. If Pope is running it more like Value & Restructuring, then the record at Contrarian Core has less meaning. By this time next year, it should be apparent how Pope has adapted his process.

At this point, there are enough unknowns to make this fund Neutral.

Russel Kinnel is Morningstar's director of mutual fund research. He is also the editor of Morningstar FundInvestor, a monthly newsletter dedicated to helping investors pick great mutual funds, build winning portfolios, and monitor their funds for greater gains. (Click here for a free issue). Mr. Kinnel would like to hear from readers, but no financial-planning questions, please. Follow Russel on Twitter: @russkinnel.

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