Three Large-Cap Funds Due for a Comeback

With 2004 behind us, investors are being deluged by articles feting funds that finished the year atop their respective categories. While these offerings often deserve the recognition, it doesn't always pay to acknowledge last year's winners. In fact, just as many value investors scour the stock tables to identify stocks hitting their 52-week lows, I enjoy looking to see which funds lagged their peers in the previous year. (In fact, Morningstar FundInvestor even goes so far as to annually identify a trio of "unloved" fund categories, with the hope that categories with high asset outflows offer investors the prospect of good future returns.) 

As such, as I've recently come across several postings on our conversation boards discussing whether it made sense to hang on to some of 2004's laggards, I thought it might be worthwhile to write a column focusing on when it makes sense to hang on to an underperforming investment. And I came up with three ideas--including two prominently discussed in many conversation-board postings--in which investors may even want to add new money to their investments.

But before I focus on those funds, it's worth repeating that while performance is the easiest thing to evaluate, it's also not the end-all and be-all. In particular, it's worth remembering that any good strategy--active or passive--is going to hit a rough stretch at some point; it's virtually impossible not to if one is going to stay true to a discipline. That means investors shouldn't be totally alarmed by one, three, or even five years of underperformance, especially if the reasons for their purchase of a fund remain intact. That is, if the strategy isn't altered and the same management is around, don't be too eager to pull the trigger.

That's what I fear some investors might now be thinking of doing with  Clipper (CFIMX) and  Jensen (JENSX), both of which lagged peers in 2003 and 2004. Both funds shone during the bear market, so their assets grew even during those tough years, but they've underperformed in the subsequent rally. Yet, nothing has fundamentally changed in the way the funds' managers execute their strategies and the management teams are unchanged. As such, they represent intriguing opportunities to me. (Also falling in this camp is the now-closed  Longleaf Partners International (LLINX), which, like Clipper, has lately let cash build due to a dearth of new investment opportunities.)

In fact, much of Clipper's recent underperformance owes to the fact that management simply hasn't bent its strict valuation criteria. The last time cash rose to these levels, we got a pretty severe bear market, so their caution isn't misplaced. In Jensen's case, the fund's love for the market's largest stocks is the reason why it's trailing peers. Over the long haul, though, its record of owning blue-chip businesses is topnotch, so I wouldn't be frightened away by the short-term underperformance.

Similarly,  Fidelity Dividend Growth's (FDGFX) relative performance has been hamstrung by its fondness for blue-chip multinationals. But we're increasingly hearing from a lot of respected portfolio managers that the best values are among larger-cap stocks. Thus, while this fund has encountered two frustrating years of lowly relative performance, it--and others like it--likely deserves a look for the very reasons that have limited it. And, more importantly, investors here shouldn't forget that nothing has fundamentally changed in the fund's basic approach.

Finally, you'll notice that I made it a point to only highlight large-cap funds in this column. There's a good reason for that: Small caps' strong outperformance means that there simply aren't many good contrarian ideas in that segment of the market. As such, I'd be careful not to belatedly load up on funds that troll that area of the market, especially in light of the past few years' outperformance. After all, many of these funds looked lousy five years ago, when large caps were looking infallible.