Six Early Contenders for Domestic-Stock Manager of the Year

Every year in December, Morningstar's team of mutual fund analysts convene for many hours of debate on who should be the next Morningstar Fund Managers of the Year. Several deserving managers are nominated and discussed, but only three win; we have one award for domestic equities, one for international equities, and one for fixed income. As we look forward to December, we thought we'd survey the landscape to scope out some of this year's potential candidates. Below, I highlight six potential contenders for the domestic equity award. This is not the official list of the nominees for 2008 Domestic-Stock Manager of the Year. There are many talented domestic-stock managers who came close to making our list of leading candidates, and one or more of those managers could bolster their credentials during the final months of the year and make the official list. Meanwhile, one or more of the early contenders could encounter performance or other issues down the stretch and fail to be nominated.

Our criteria for manager of the year are straightforward. We look at how the candidates have performed in 2008, but their longer-term records are equally, if not more, important. We want to reward managers who have made a lot of money for a lot of people over the years, so we're more likely to recognize long-tenured skippers running larger sums of money rather than relative newcomers or those who have posted knockout returns with only $100 million or so in assets. We also consider stewardship and look for managers who treat their fund shareholders like partners. Finally, we want to have a high degree of confidence in the manager's strategy and execution to avoid rewarding strong returns that were just a fluke.

If the rest of 2008 is anything like what we've experienced thus far, it's likely that this list will change. As my colleague Gregg Wolper pointed out in a recent Fund Spy, year-to-date performance rankings are never steady and they have been especially volatile lately. Big shifts in performance, especially among financials and energy stocks, have turned leaders into laggards almost overnight and vice versa. Below, we have a list of standouts that have excelled in this rocky environment and over longer periods. We think highly of all of six management teams and the strategies they adhere to, not only for their results in what has been a bumpy 2008, but for the success they've brought to their shareholders over the long haul.

The Primecap Team: Vanguard Primecap (VPMCX)
This isn't the first time that the Primecap team has been a contender (the team won the award in 2003). Yet, the crew is deserving of being considered again. The team manages a whole host of funds--both for Vanguard and under its own umbrella--using different applications of the same tried-and-true philosophy. The managers bring a real contrarian bent to growth investing and with it have achieved one of the fund industry's best records over the past 20-plus years on the closed Vanguard Primecap fund. And thus far in 2008, Vanguard Primecap is ahead of 97% of its large-growth peers in what has proved to be a challenging year across the board. Its lack of energy and the weight of struggling technology and health-care picks were a liability in 2006 and 2007, but the fund's positioning is helping it avoid the steeper losses faced by peers in 2008.

Bruce Berkowitz: Fairholme (FAIRX)
There aren't many practitioners of Warren Buffett's style of investing that come close to the investing legend's own abilities, but Bruce Berkowitz is up there. He thinks like a business owner and knows his holdings cold. In the middle of this year, he took profits from some of the fund's large energy-related holdings such as  Canadian Natural Resources (CNQ) and Ensign Energy Services and redeployed that cash into struggling and more attractively valued health-care stocks and residential real estate companies. Although timing the market isn't his game, the timing of some of his calls has been spot on. In energy, for example, he didn't sell when most other value managers were pulling back in 2006 and 2007, and, therefore, the fund enjoyed the continued strength. When he did start to take profits a few months ago, it happened to be just before crude oil prices started to decline in July and the stocks retreated.

Bob Goldfarb and David Poppe: Sequoia (SEQUX)
This fund has been out of the spotlight for a long time, and deliberately so. Until earlier this year, it had been closed to new investors for a quarter of a century. During that time, it quietly put up great numbers for those shareholders who bought in when it was last open in the 1980s. The fund has generated top-tier long-term returns, offering downside protection and low volatility along the way. This year has been no exception. Although the fund is in the red, it has avoided the big land mines in financials and been buoyed by some strong-performing picks such as industrial fastener-maker and -supplier  Fastenal (FAST) as well as retailer  TJX Companies (TJX). A pure stock-picker's vehicle, it bears no resemblance to the major indexes, making it a great portfolio diversifier.

Harry Burn, Gibbs Kane, and John DeGulis: Sound Shore (SSHFX)
Plenty of value managers missed the risks in financials, but not this team, which has stayed out of trouble by executing its value strategy well. The team has no interest in turnaround stories if there's a real risk that the company could fail. More generally, it looks for solid balance sheets and strong free cash flow, and it wants to have confidence in knowing what a company will earn in the next few years. By sticking with that philosophy, the managers avoided nearly all of the financials that suffered the worst subprime-mortgage damage, as well as homebuilders. As a result, the fund's moderate year-to-date loss puts it ahead of 98% of its category peers. Over the long haul, the fund's results have shone in both absolute and relative terms.

The Team at Jensen (JENSX)
It's nice to see Jensen Fund climb back up the ranks. Before this year, four of the previous five didn't look so good in relative terms here. Jensen Fund has always had a high-quality bias, and that hurt it when energy and other cyclical fare were skyrocketing and this fund's health-care and consumer stocks were struggling. Its positioning is the result of management's demand that its picks have a history of generating at least 15% returns on equity over each of the past 10 years and sell at a significant discount to their estimate of intrinsic value. That focus has led to an eclectic portfolio that has hurt during stretches favoring riskier fare, but it has served the fund well over time. Its 10-year return through the end of August is in the top 10% of all large-blend funds.

Scott Satterwhite, James Kieffer, and George Sertl: Artisan Small Cap Value   and Artisan Mid Cap Value (ARTQX)
The small-cap value fund run by this team is the only one on our list that has actually made money this year. (The team also manages Artisan Mid-Cap Value, which is flat for the year but in the top percentile of its peer group). That's a result of its focus on smaller companies, an area that has been spared some of the pain that larger caps have felt. Smaller-cap companies did, however, experience a sharp pullback in 2007 and early 2008 after years of hot returns, and this team did well in that environment. The team has also been competitive in good times and most importantly over the long haul. The ticket to the team's success has been in its valuation work. The managers think like private buyers and demand steep discounts before buying in. That doesn't compel them to buy garbage companies, though. The outfits held in these portfolios tend to be cash-rich and carry low debt levels. Besides great execution of a sound philosophy, the team has tried to preserve its flexibility by closing both strategies at low asset levels. Both funds are currently closed.