Baseball Gives a Lesson On Relative Return Limits

The Chicago Cubs were recently bounced from Major League Baseball's playoffs by the Arizona Diamondbacks. We should have seen it coming. Forget goats and curses. This was all about the numbers. And the numbers said Arizona had the better team. The Cubs and Diamondbacks both won their respective divisions, but those groups were not equal. Arizona topped a strong division, while the Cubs barely won baseball's weakest. In fact, more than a third of baseball's 30 teams had better records than the Cubs'. Clearly, topping a weak group doesn't always equate to absolute strength. And just as important, quality teams are often hidden in the middle of tough groups.

The same is true in investing. We sort funds by similar styles so that we can make apples-to-apples comparisons among peers. Such comparisons are important. But, they should always be set against a backdrop of absolute performance. As the old saying goes, you can't eat relative returns. A glance at the 10-year annualized returns for Morningstar's domestic- and foreign-stock categories shows a range from 15.7% down to 2.3%. In the basement are Japan stock funds. Even the top-rated funds in this category haven't meaningfully compounded capital over time.

At the opposite end of the spectrum are 10 categories in which the typical fund has returned more than10% annually over the past decade. We trolled these waters and found plenty of funds that we think highly of, even though their current rankings and ratings don't appear great.

Below is a sampling of some of the best of these 'better than they currently look' funds. They're not hidden gems, as most come from top shops. None rates higher than 3 stars, so they may be overlooked by those simply screening on rankings and ratings. A couple of funds are closed to new investors. We think shareholders should consider adding to their stakes in these, and the funds that remain open would make worthy additions to a portfolio.

 Tweedy, Browne Global Value (TBGVX)
This closed foreign small-/mid-value fund is an all-cap offering in a small category that leans heavily toward international small caps--one of the strongest asset classes over the past decade. The fund also hedges all of its foreign currency exposure, which has left it lagging peers whose returns have been juiced by currency gains. Still, the fund has returned an average of 11.6% annually over the past decade--solid by anyone's standards. A surge in large caps and a change in currency trends would only enhance the fund's appeal.

 Weitz Hickory 
A contrarian, Wally Weitz will trade near-term pain for long-term gain. Recently he has paid a price for adding to stakes in the troubled mortgage and finance sectors. The fund has lost 3.7% so far in 2007--among the worst in the mid-cap blend category. The recent underperformance has also dragged down the fund's long-term returns as well. But we have full confidence in Weitz. He's been early before, but rarely wrong. The fund has returned nearly 13% annually since its 1993 inception. Weitz is down, not out. Now's the time to add to this fine fund.

 Selected Special (SLSDX)
This analyst-driven fund takes the best ideas from the research staff at Davis Advisors, one of the top shops in the business. With a flexible, all-cap purview, it's a bit of a square peg in a round hole in the mid-cap blend category. The portfolio has migrated between the core and growth, and mid- and large-cap portions of the style box. A large-cap focus has held it back relative to its peers in recent years, and an above-average financials stake has hurt it a bit so far in 2007. So, it recently slipped to a 3-star rating. But the fund has generated solid returns since Davis Advisors took over in 2001, and we think its best days are ahead of it. Morningstar's 2005 Domestic-Fund Managers of the Year Chris Davis and Ken Feinberg keep watch on the analysts here, and their track record at their offerings is topnotch

 Third Avenue International 
This is the ultimate go-anywhere international fund. Manager Amit Wadhwaney takes Third Avenues' proven safe-and-cheap approach to all corners of the globe. No market is too esoteric and no stock is too obscure for him--as long as its meets his value criteria. The portfolio includes a number of stocks that are owned by only a handful of other funds. Wadhwaney typically holds stocks for well over five years. The fund can be out of step with its peers at times as individual stock stories unfold. Wadhwaney refuses to overpay for stocks, so he shuns the hottest areas of the market. Thus, even though the fund has returned an average of 26.4% annually over the past five years, it lags its riskier peers. But we have full confidence Wadhwaney will deliver an outstanding risk/reward profile over the long haul. This fine fund is closed to new investors, but shareholders should consider bolstering their stake.

 FPA New Income (FPNIX)
This distinctive intermediate-term bond fund is a Fund Analyst Pick. Manager Bob Rodriguez doesn't follow the herd. He pays no heed to the benchmark in his quest to preserve capital while generating good long-term returns. Concerned in recent years about possible inflationary pressures and the lack of a risk premium in the market, he has kept this fund defensively positioned. Its duration is extremely short, and it recently kept nearly a fourth of its assets in cash. That has hurt at times, but the fund's long-term returns are good and it is among the lowest-risk funds in its category. It has never lost money in a calendar year since it launched 23 years ago. This one's a winner.