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Do These Comeback Kids Have Long-Term Prospects?

A closer look at a dozen resurgent U.S.-stock funds.

Dan Culloton, 08/08/2013

This year's rising stock market has buoyed a lot of funds whose relative returns had sunk over the past five years.

The domestic-equity funds we examine below still carry five-year returns ranking in the bottom fourth of their categories, but they have surged to the top quartiles of their peer group so far this year.

What's the long-term potential of these comeback kids?

The Wild Bunch
He's back--but for how long? Bill Miller, who beat the S&P 500 15 years in a row and then fell off a cliff, is on top again this year at Legg Mason Opportunity LMOPX. The fund's nearly 44% year-to-date gain through Aug. 5, 2013, beats 98% of its mid-blend peers and is about 20 percentage points ahead of the Russell Mid Cap Value Index and the S&P 500. Much larger than average helpings of mortgage insurers MGIC Investment MTG and Radian Group RDN, as well as digital entertainment names Netflix NFLX and Pandora Media P have propelled this fund's resurgence. Each stock has more than doubled this year, but they have something else in common: Not long ago, for different reasons, investors held each of them in lower esteem than Congress.

Such is the pattern with Miller and this fund. He was an aggressive contrarian investor with a taste for ugly, unpopular, and unconventional stocks during his very public rise and fall at Legg Mason Capital Management Value Trust LMVTX, and he remains so at this more wide-ranging fund. Results have been extreme. In the past decade, Opportunity has finished as many years in the bottom fourth of its category as it has in the top. The fund's performance should remain fickle due to its larger than average stakes in companies that, according to Morningstar equity analysts, lack clear competitive advantages and that, on average, have higher debt/capital ratios. It hard to confidently say this fund won't suffer another reversal.

The same could be said for Miller's successor Sam Peters at Legg Mason Capital Management Value Trust. Like its sibling, the performance of some aggressive stock picks, such as Celgene CELG and Groupon GRPN, have helped that fund so far this year. Like Miller, Peters has an appetite for lower-quality fare and that has resulted in erratic performance since he became comanager in 2010 and lead manager in 2012. His record at Legg Mason Capital Management Special Investment LMSAX, which he has managed since 2006, also is lacking. So, there's not much to go on here.

CGM Focus CGMFX also is too mercurial to call. As we have written before about this omnivorous, high-turnover fund, its only consistent attribute is its inconsistency. As long as Ken Heebner is at the helm, it will veer from one end of the performance tables to the other. Investors who have bought this fund at one of its many tops have often been disappointed. Through the end of July the fund had lost more than 6% annualized over the past five years, but according to the fund's investor returns, which factor in shareholder purchases and sales, the typical investor here lost more than twice that--more than 14% annualized--by buying high and selling low. This has been an especially difficult fund to use effectively.

Dan Culloton is an associate director of fund analysis for Morningstar and editor of Morningstar's Vanguard Fund Family Report, a monthly newsletter that offers independent, no-holds-barred guidance on the pros and cons of this dominant fund family. Click here for a free issue of the Vanguard Fund Family Report.

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