Should You Stick With Managers Having a Subpar Year?

It's no secret that some of the better mutual fund managers are having a tough year thus far in 2007. Not willing to leave the task to others, Bill Nygren of  Oakmark Fund (OAKMX) and  Oakmark Select (OAKLX) told everyone himself how lousy his funds have performed in a letter to shareholders posted on Oakmark's Web site. And the financial media has made sure that you know that Bill Miller's  Legg Mason Value (LMVTX) is again lagging the S&P 500 Index and nearly all of its peers, just as it did in 2006.

Regular readers of Morningstar.com know that we still have confidence in those top-level managers. But the big names aren't the only ones struggling this year. Several less-well-known managers of funds in Morningstar's large-blend category currently share space in the basement with Nygren and Miller.

In such cases there's always one caveat and two key questions. The caveat: One year, or part of a year, is too short a time period to properly evaluate any fund. The only reason we occasionally highlight such situations is because we know many shareholders, or other investors, are curious to know the answers to the two questions that arise in these situations: What accounts for the lousy showing so far, and more important, are these funds still worth owning or does their short-term struggle actually result from a deeper problem?

In all three of the following cases, we don't think you should turn against the funds because of an eight-month ranking. But that doesn't mean you should jump into all of them, either.

 Cambiar Opportunity (CAMOX)
Prior to 2007, this fund had an outstanding record, consistently outpacing the rest of the large-blend category and the S&P 500. Remarkably, this offering, founded in 1998, had landed in the top quartile of the category every year from 1999 through 2006, except for one year when it "only" reached the 34th percentile. Its annualized return during that period was 12.2%, trouncing the category average of 4.3% and the S&P 500's 3.4%. This year, the fund finally hit the inevitable rough patch. Through August 29, the fund is 0.4% in the red, landing in the 96th percentile of its group and trailing the index by nearly 5 percentage points.

There have been various culprits. A couple of holdings have been hit hard because of association with the subprime problems:  Washington Mutual (WM) (which the fund's managers have sold) and bond-insurer MBIA. Several other stocks in the top 20 as of June 30, including  Home Depot (HD), have also suffered double-digit losses. Conversely, a lack of substantial weightings in industrials and materials stocks, which have held up comparatively well, has hurt the fund relative to rivals.

Given the fund's exceptional long-term record spanning a variety of market conditions, long-tenured management team, and solid strategy, it's easy to stick with it . True, it had a minuscule asset base during its early years, and has had to cope with growth in assets over the past few years. Still, at $2.6 billion, it's hardly at a size where bulk should hamper its style, given its preference for large and midsized companies and a restrained turnover rate. Its managers have been on board either since the fund's inception or within a few years after. It doesn't seem like anything has changed here; rather, the fund is, for one rare time, out of step. It seems likely it will return to form and remain a fine long-term investment.

 Madison Mosaic Investors (MINVX)
This fund has only about $150 million in assets despite having been around for nearly three decades and having run up a nice long-term record prior to this year. The fund changed to its current all-stock format from a balanced strategy in 1996, and over the 10-year period from the start of 1997 through 2006, it beat both the S&P 500 Index and the large-blend category average, with milder-than-average volatility. The fund stood out most notably during the bear market: In each calendar year from 2000 through 2002 it beat at least 85% of its large-blend rivals.

This year has been tough, however. Through August 29, it's posting a 1.3% loss, landing in the category's 97th percentile and falling more than 5 percentage points behind the S&P 500. Lead manager Jay Sekelsky (who's been on the fund since 1990) doesn't like energy stocks, partly because their performance depends so much on commodities prices that fluctuate due to world events that are very difficult to forecast. That has hurt this year, as it did in 2005. Unlike Cambiar Opportunity, this fund has a minimal amount of double-digit losers in its top 25; the problem here has been the amount of stocks posting smaller losses, such as top-five holdings  Novartis (NVS) and United HealthCare, and having practically no big gainers to offset the many losers.

This fund isn't quite the standout that the Cambiar offering is. However, we do like its chances of recovering to be a solid long-term holding. Sekelsky's detailed research and cautious approach has paid off during downturns, and prior to this year, the times his fund has lagged have tended to be during big rallies, as in 1999 and 2003. A focus on the biggest of the big stocks and an avoidance of energy won't always be negatives as they have been in the past few years.

 Legg Mason Partners Capital 
This fund lags 90% of its large-blend rivals for the year to date through August 29, and it's easy to find the main culprits. Lehman Brothers , which had more than 3% of assets as of the June 30 portfolio, is down 30% this year; Motorola (MOT) and Marsh & McLennan (MMC), each with more than 4% of assets, are down 19% and 13% , respectively. And those aren't the only significant holdings in this compact portfolio deep in the red this year. The few sound performers such as Aflac and Cisco Systems haven't been powerful enough to counterbalance the problem stocks.

Brian Posner, who manages this fund with Brian Angerame, had much success as a manager with Fidelity and Warburg Pincus before starting his own hedge-fund firm. He returned to the mutual fund world in 2006 to run ClearBridge Advisors, the successor to the Smith Barney and Salomon Brothers advisory groups. He told Morningstar last week that he still has confidence in all of the above-named companies, citing advantages they have along with attractive valuations, and says they remain solid long-term plays.

As with the first two funds outlined, it would be wrong to turn sour on this one based on the first eight months of 2007. In fact, the fund's 12-month ranking, reflecting the full tenure of Posner and Angerame, is much better. And it's true that making a long-term commitment to deeply out-of-favor companies with a reasonable chance of a comeback, such as Motorola, is the sort of thing he's done in the past and which is a hallmark of other top managers.

That said, we can't be as confident in this fund's outlook, simply because Posner and Angerame don't have the track record at this particular fund, and firm, as the other managers of the other funds named above do at theirs. Posner's hedge-fund track record has not been made public; his success at other mutual funds was with different analysts at very different companies. It has potential to be a strong fund, and this year's subpar start is no reflection on its managers' abilities; it's only for these other reasons that it's not a compelling pick now.