Our Nominees for Domestic-Stock Manager of the Year

After a very bad year in the markets, I find myself writing a rather odd column about our nominees for Domestic-Stock Fund Manager of the Year. About the best any fully invested domestic-stock fund manager could do this year is lose 30%, while those having an off year are down twice that amount.

Yet, these nominees are as deserving as those in huge up years like 1999 and 2003. Limiting losses in a down market is more important to helping investors meet their long-term goals than maximizing gains in a rally. The argument that these funds should go into cash or shorts when they see a bear market coming doesn't hold up because most equity funds are required by prospectus to invest mostly in stocks and some with an equity-specific name have to be 80% or more in equities. Moreover, virtually no one has consistently timed the market to produce better long-term results than buy and hold investing. Finally, if you bought a fund that never piled into cash or shorts in its history it's illogical to expect that to happen.

Our manager of the year award recognizes not just superior single-year performance, but also great long-term performance. In particular, we want to reward managers who made a lot of money for a lot of people. Our 2007 winner Will Danoff, for example, put up outstanding results with billions of dollars in his fund. That's much more difficult and more important than earning a strong return in a $10 million fund. We also look for managers who are great stewards of shareholders' interests and who stay with their proven strategies rather than follow investing trends.

Without further ado, here are this year's nominees:

Bruce Berkowitz of Fairholme Fund (FAIRX)
Berkowitz was the odds-on favorite in August, by avoiding financials like the plague and selling much of his energy positions near the energy peak in June and July. However, a falling market led him to invest more, and some of his favorite stocks got thumped in the fall. Now the fund's 34% loss is greater than any other nominee's. Still, he merits the nomination for doing an excellent job this year and in every year since he started the fund. Few Buffett-inspired managers have done a better job putting his philosophy into practice. He builds concentrated positions in well-run companies and is very patient in waiting for a reward. He also allows cash to build when he can't find good investments. This decade has been a treacherous one, but you wouldn't know if from this fund's performance.

Scott Brayman of  Champlain Small Company (CIPSX)
Brayman and his team have done an excellent job plying a valuation-sensitive small-cap growth strategy since setting up shop in 2004. Prior to that Brayman had eight strong years at  Sentinel Small Company (SAGWX). The team's attention to valuations and strong cash flows has helped it to withstand the market deluge so far in 2008. By looking at the top holdings, you can see the fund has largely avoided the stocks that suffered outsized losses. We also give big points to Brayman for closing the fund in a timely manner. When he set up shop he said he'd close when all assets in the strategy reached $1.5 billion, and he stuck to it. No doubt that helped to give him the flexibility to produce strong performance rather than getting slowed by bloat.

Chris Browne, William Browne, and John Spears of  Tweedy, Browne Value  (TWEBX)
Once again Tweedy's patient conservatism has come through for shareholders. The venerable firm follows a Ben Graham approach to value. That and its penchant for all stocks of all market caps have kept the fund from standing out in recent years, yet here it is again with a strong year and strong trailing returns. The firm's roots are in a brokerage that focused on hard-to-get thinly traded stocks (Warren Buffett bought his first Berkshire shares there), and there's still a clear interest in lesser-known value stocks--though they've since included large caps and plenty of foreign stocks to their portfolio mix. Lately, they've found a number of bargains in the market but they'll patiently wait in pricier markets for cheap stocks to emerge. These guys hate to lose clients' money and it shows in their 27% loss this year and in their superior long-term performance.

Harry Cohen and Scott Glasser of  Legg Mason Partners Appreciation  (SHAPX)
Hersh Cohen and Scott Glasser's fund has been through a few name changes over the years but its strategy and performance have not. The fund was part of the Shearson line-up, was renamed Smith Barney when the firms merged, and was renamed again as Legg Mason when Legg Mason acquired Citi's asset-management business.

Through it all, Cohen hasn't missed a beat. He's run the fund since 1979, and Glasser has been there with him since 1995. (Check out our  analysis archive which goes back to 1993.) Cohen and Glasser look for clean balance sheets and reasonable valuations--an approach that means that they sometimes lag in rallies but hold up nicely in down markets. This year they're down 31%. That sounds grim but that's nearly 800 basis points better than the S&P 500. Over the past 15 years they're modestly ahead of the benchmark, but they got there with significantly less risk.

Charlie Dreifus of  Royce Special Equity (RYSEX)
Every portfolio should have at least one fund like this. When times get tough and accounting scandals emerge, Dreifus' portfolios are an oasis of calm. That's why his fund is down just 24%. He's built a good record here and during two previous fund managing stints. I spoke with him in 2002 amid the last accounting mess, and this is how he described his process.

First, he runs screens based on valuation and profitability. "Then I pore over the notes and the statements looking for things like the amount of stock option dilution," he says. "I also look at pension expenses or income. Some companies' income is derived from an overfunded pension plan, but that's not indicative of the operating business. Then, I check for contingencies such as those surrounding litigation. Occasionally that's actually a positive, because a company can be a plaintiff, too."

In addition, Dreifus takes a long look at joint ventures and minority positions in businesses. "You need to understand how they're structured because, as Enron showed, the debt and other liabilities aren't consolidated in earnings," he says.

"In the 10-k, I look for reserve accounts having to do with provisions for bad debts and obsolete inventory. These give a sense for the direction of the company. Also, companies can use these to smooth earnings. I also look at advertising expenditures because they could be used as a smoothing technique. If you want to reduce earnings, you step up ads and vice versa."

Robert Goldfarb and David Poppe of  Sequoia Fund (SEQUX)
Earlier this year, Sequoia Fund reopened for the first time in a generation, and we made it a Fund Analyst Pick. Some readers questioned our wisdom now that legendary managers Bill Ruane and Richard Cuniff are gone. However, we think they did a good job preparing the next generation to take over. Goldfarb has been working on the fund for more than 20 years and he's been a comanager for a decade. Like Buffett, who recommended his partners invest in Sequoia fund when he rolled up his partnerships, Sequoia Fund's managers have become more open-minded about growth rather than just look for super cheap stocks. They run a concentrated portfolio of stocks with high-quality management and long-term competitive advantages.

This year, a hefty financials weighting hasn't prevented the fund from beating its peers and its benchmark by a wide margin. They prefer insurers like  Berkshire Hathaway (BRK.A) and  Progressive (PGR) to investment banks and money center banks, which have imploded. Over the past 10 years they've beaten the S&P 500 by nearly 300 basis points annualized.

Nicholas Kaiser of  Amana Trust Growth (AMAGX),  Amana Trust Income (AMANX), and  Sextant Growth (SSGFX)
To appreciate what Nicholas Kaiser has done at this fund, check out his funds' annual returns. Through all of the market's wild swings, Kaiser's funds have put up great returns. He had good performance in speculative growth years like 1999 but the funds didn't fall apart in the ensuing bear market, nor did they in this one. True, the Amana funds' Muslim screens bar investments in financials, but Kaiser did well when those screens would have held back returns. In addition, Sextant Growth doesn't have those limitations and it did well, too. Kaiser applies a growth-at-a-reasonable-price strategy, which doesn't sound too different from many other funds', but his execution has been superior. This year strong health-care names like  Amgen (AMGN) and  Genentech  have been a boon. In addition, performance was aided by sizable cash stakes of around 20%.

Clyde MacGregor and Ed Studzinski  of Oakmark Equity & Income (OAKBX)
To be sure, running a fund that's half Treasuries and half equities does give management a leg up on pure equity managers in a year like this one. Yet the fund's long-term success owes to excellent stock selection. Steady growers like  CVS (CVS) and Nestle have limited losses this year but over the past 10 years they've led to a powerful 9% annualized gain. In addition, energy and defense plays have been a big help, though obviously the energy stocks have shed their gains this year. MacGregor and Studzinski look for companies that produce strong cash flows, and they've done a good job avoiding some of the financials that have tripped up other funds at Oakmark.

John Osterweis of Osterweis Fund (OSTFX)
John Osterweis embodies the characteristics we like at a number of our nominees. He's not interested in running a lot of money or getting a lot of publicity. He just quietly runs his firm with a focus on making money for clients. This fund began as a vehicle for friends and family without enough money to invest directly with Osterweis and the fund world can be grateful for it. Osterweis has stayed out of fund NTF programs in order to avoid hiking fees. He's a choosy manager who owns only about 30 names in his portfolio. And it's no wonder--consider that he wants strong cash generation, good managers, a defensible niche, a catalyst for near-term growth, and long-term growth potential. He's built an eclectic portfolio which has come through in each of the two bear markets this decade and has still earned solid returns in the good years.

Bob Perkins and Tom Perkins of  Janus Mid Cap Value and  Janus Small Cap Value (JSIVX)
As strange as it sounds, Janus Mid Cap Value's 32% loss makes it one of the best mid-value performers. A focus on cash flow and clean balance sheets guided it away from the worst mid-value names--particularly those hurt by subprime. On the downside, it does have a fair amount in oil stocks that have been punished. This year's performance validates its cautious approach which sometimes leads the fund to lag in rallies. More importantly, Janus Mid Value and Janus Small Value have top-decile long-term returns with low risk.

The Perkins' strategy is to look for stocks trading at new lows that have clean balance sheets and strong cash flow. This year they've benefited from a timely exit from REITs and strong stock selection among financials. Small Value remains closed to new investors, but Mid Value is open.

Robert F Zagunis, Robert Millen, and team of  Jensen Fund  (JENSX)
Steady-growing blue chips had been out of favor for years, but that didn't bother Robert Zagunis, Robert Millen, and the rest of Jensen's team. They like high-quality growth stocks and they stick with them. This year that strategy looks pretty sane. Their companies have tremendous value that a recession won't wipe out. Nor are they very dependent on lenders for financing because they have strong cash generating businesses. This year the fund's 30% loss is a whopping 1,200 basis points better than those of the average large-growth fund. Shareholders are no doubt pleased that management didn't lose its nerve when its strategy was out of favor. They also get bonus points for having the lowest expense ratio of any of this year's nominees.

The 2008 Fund Manager of the Year winners will be announced on Morningstar and CNBC on Tuesday morning, Jan. 6, 2009.

Also see our Fixed-Income and International Manager of the Year Nominees.

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