A Search for Time-Tested, Highly Selective Managers

No matter the market environment, Morningstar's fund analysts have heard various fund managers proclaim that "it's a stock-picker's market." The clear implication is that the stock-picker in question will do a superior job of picking the right stocks in the near future and beat his or her benchmark and rivals. But one could argue that the familiar selling point is especially resonant now: While the valuations of so many stocks are down sharply following 2008's plunge, the economy is in bad shape, consumers appear tapped out, and borrowing money still isn't very easy. The number of companies that not only survive through these tough times but generate profit growth that justifies a rise in their valuations could be relatively few if conditions don't improve soon or if they even worsen.

Given these possibilities, we think it makes sense to use Morningstar's  Premium Fund Screener to identify funds run by managers with at least 10 years of tenure who keep their portfolios compact (50 holdings or less), who navigated the treacherous market of the past 12 months relatively well, and who have generated top-third long-term returns. We eliminate funds with Morningstar Risk ratings of "high" so investors aren't subjected to extreme volatility. We're also sticking with funds that invest primarily in big firms so investors have core holdings from which to choose. And, of course, we want to home in on funds with below-average costs because they have a built-in advantage over their rivals. To view the results as of Jan. 20, 2009, click here.

 Chase Growth (CHASX) is an underappreciated gem. Lead manager David Scott, who's run this large-growth fund since its December 1997 inception, and the team that supports him seek out firms that have long records of consistent profit growth, relatively little debt and stock purchases by insiders, and other demanding criteria. Unlike some rivals, Scott and company set fairly conservative price targets on their holdings and sell quickly, thus avoiding the blowups that occur when pricey fare fails to meet lofty earnings expectations. For example, management slashed its stake in energy stocks when they soared in 2008's second quarter, sparing shareholders significant losses as those stocks fell to earth in the latter half of the year. The one energy firm the fund held on to was  ExxonMobil (XOM), which has weathered the storm far better than its peers thanks to its diversified operations. Despite a concentrated portfolio of 30-45 stocks, the fund has been a relatively consistent performer thanks to the team's risk-conscious approach and deft stock selection. We think that the team's efforts to limit both price- and balance-sheet risk will serve the fund well when the macroeconomic environment is gloomy.

 Franklin Rising Dividends (FRDPX) tends to thrive when times are tough. That's no surprise, given its approach--the fund, which also passed our December screen for income-producing funds, favors companies that have raised their dividends over eight of the previous 10 calendar years, have doubled their total payouts over that span, and sell for modest valuations. That tack means a portfolio of financially sturdy fare such as top holding  Procter & Gamble (PG) that can look sluggish when credit is easy to come by and leveraged firms fiercely rally. But the fund boasted a sizable gain in the 2000-02 bear market and lost 11 percentage points less than its rivals in 2008, because investors tend to stick with companies with steadier revenues and healthier balance sheets when the economy goes south. And management has done a fine job of identifying firms of that ilk that are particularly undervalued. For example,  Wal-Mart (WMT), one of the fund's biggest holdings, managed a 20% gain in the midst of 2008's carnage and  Family Dollar  rose 39%. To reap the rewards of the fund's cautious approach, investors need to be patient when it goes through dry spells, but they get a veteran team of stock-pickers (the four managers' average tenure is 19 years) for a reasonable 1.01% expense ratio.

The duo of Harry Burn and T. Gibbs Kane has plied the same price-conscious strategy at  Sound Shore (SSHFX) since its 1985 inception. It's not exactly a showy approach: They look for companies selling cheaply relative to their historical valuations with solid business fundamentals. Burn and Kane have simply been better at straightforward value investing than most. Their penchant for avoiding companies with the shakiest growth prospects and balance sheets kept them out of the financial firms that imploded in 2008--despite a significant weighting in the sector--which helped the fund edge out its typical rival (though it has registered a sizable absolute loss of 34% over the past 12 months). That's typical here--the fund rarely blows away its competition in a single year, but management's ability to limit risk has made the fund remarkably consistent despite a 40-stock portfolio (and should give the fund a significant edge if the market remains bleak and companies continue to go under). It's finished in the category's top half in nine of the previous 12 calendar years. Those small victories have added up: The fund lands in the category's best quartile over 10 and 15 years.

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