Announcing Morningstar's Managers of the Year for 2010

The markets were good to mutual funds in 2010, as most managers continued to climb their way back from losses incurred between 2007 and early 2009. Growth led value. Small caps led large caps. Emerging markets shone brighter than many developed ones. And equities were well ahead of fixed-income investments. Funds with healthy doses of industrial, consumer discretionary, and real estate holdings were rewarded. Meanwhile, lagging financial and health-care stocks created a drag for funds with significant stakes in those sectors.

As with any investment backdrop, some fund managers' styles were in favor and helped elevate them to the top of the performance charts. Yet, our winners' great returns cannot solely be explained by an ephemeral stylistic tailwind. We look for managers who nailed the past year on the heels of much lengthier success, and we measure this success not only by observing trailing performance, but also by reviewing managers' research and actions over time.

Morningstar gives three awards each year: Domestic-Equity Manager of the Year, International-Stock Manager of the Year, and Fixed-Income Manager of the Year. In early December, fund analysts specializing in those fields narrow down the universe to five nominees for each award, and the winner is then selected by Morningstar's entire team of mutual fund analysts. To make the most informed decision, we comb through portfolios, returns, stewardship, and our own long institutional memory of these funds as we debate and vote. While the award has always distinguished the past calendar year, we've never simply chosen the highest-returning funds. We favor managers who have achieved strong risk-adjusted performance through the careful execution of a solid investment strategy. And we esteem good stewards of investors' capital.

The award is more an acknowledgement of managers' past achievements than a prediction of future results. This is not an attempt to pick the best manager for the following quarter or year. Even so, we're confident this year's winners--and past ones--have great long-term prospects because our selection process focuses not only on results, but also on how those results were achieved.

The winners for 2010 are:

Domestic-Equity Managers of the Year
Robert Goldfarb and David Poppe of  Sequoia Fund (SEQUX)
You can't point to one savvy move or big bet that clinched the award for Goldfarb and Poppe. Sequoia is rooted in decades of deep individual-company research and deft execution of a winning, time-tested investment formula. The managers look for companies with enduring competitive advantages, strong balance sheets, and quality management. They buy when valuations look compelling and hold for the long term. The fund's turnover regularly clocks in below 15%.

Sound like a strategy from Warren Buffett's playbook? It is. Buffett has played a role in the fund's success by not only inspiring management's investment philosophy from the very beginning, but also by running  Berkshire Hathaway (BRK.A), one of Sequoia's largest holdings since 1990. Anyone could have bought Berkshire 20 years ago and held on, but very few have. It's far easier for scores of investors to play lip service and point to Buffett as a guiding light, but it has proven very difficult to emulate him with true investment success. The Sequoia team has done it.

Many of the fund's large positions and biggest winners in 2010-- TJX (TJX),  Idexx Laboratories (IDXX), and  O'Reilly Automotive (ORLY)--have been held in the portfolio for more than five years. So 2010 was less about recent maneuvers or new picks panning out, and more about a compact, long-held portfolio firing on all cylinders.

The researchers behind Sequoia's success have demonstrated excellent stewardship, too. Until 2008, the fund had been closed to new investors for 25 years. That has kept the team focused on investing and away from the distractions of marketing the fund to new investors or absorbing new assets. Even today, the fund can be difficult to buy because it doesn't pay for distribution and therefore is not readily available on many popular brokerage platforms.

International-Stock Manager of the Year
Brent Lynn of Janus Overseas (JAOSX)
Yes, it is true that much of the fund's success has been due to emerging markets, but Brent Lynn has looked for opportunities beyond those markets and has found them. For example, he bought  Ford Motor Company (F) and  Delta Airlines (DAL) when their prospects looked dim, and held them as they rallied in the latter part of 2009 and 2010. Lynn is a talented stock-picker rooted in deep fundamental research and is adept at spotting future growth before others see it.

Lynn's portfolio is aggressive by most standards--it leans heavily on growth stocks and emerging markets and loads up on some sectors while avoiding others. The fund's standard deviation is well above average; beta is high. Yet, a closer look reveals a healthy mix of aggressive growth stocks and downtrodden value plays--and an impressive record of finding examples of both that work out. The world is his oyster, as his recent 19% stake in U.S. companies shows. The current U.S. stake is more than two times the average for this portfolio since Lynn took sole control. As the portfolio's own complexion changes, it never looks like its benchmarks or competing funds.

While the fund's 19.3% gain in 2010 is impressive, you may be surprised to hear that the resiliency of Lynn's strategy is what really clinched the award. We've long anticipated that the fund would struggle in environments unfavorable for emerging-markets and growth stocks. Indeed, it lost 60% from the market's peak in October 2007 through its trough in March 2009.

However, Lynn has more than made up for it by showing resolve in his research and strategy when it mattered most. Many of the struggling companies he stuck with and even added to when things looked awful fueled a 78% gain in 2009. Despite those steep losses a few years back, the fund is up an annualized 13.6% for the trailing five years through the end of 2010--a feat no other diversified foreign-stock offering has achieved. In fact, the next-strongest performer in the fund's foreign large-growth category falls a full 6 percentage points behind on an annualized basis over that rocky five-year period, with many still sitting on losses.

Fixed-Income Manager of the Year
Michael Hasenstab of Templeton Global Bond (TPINX)
One of Hasenstab's largest bets in the portfolio worked against it in 2010, but, with a gain of 12.7%, he still managed to finish in the top 10% of his world-bond peers.

In 2010, Hasenstab sold short the Japanese yen versus the U.S. dollar, believing that the spread between U.S. and Japanese government yields would widen, with U.S. rates moving higher. The short yen position was equivalent to roughly 20% of assets; with the yen up more than 12% versus the dollar in 2010, that wager hurt. The fund held enough winning positions elsewhere to overcome the drag, though, and ended the year with a comfortable lead. In 2010, as in past years, the fund was clearly helped by its diversification, which is important because currencies can be extremely volatile and sentiment about global markets shifts quickly. Hasenstab's strategy is based on long-term macroeconomic fundamentals and valuations. He's patient when he needs to be--for example, he's remained steadfast in his view and position on the yen despite the fact that it has worked against him.

Hasenstab was skeptical of developed markets long before most others even acknowledged they were in the throes of a full-blown crisis. That's because he favors growing economies with little debt over stagnating ones with weak balance sheets. That's led him to emerging countries instead of the developed markets that play a dominant role in world-bond benchmarks and rival funds. Longstanding positions in markets such as South Korea, Malaysia, and Brazil have been strong contributors to the fund's recent success, while limited exposure to the euro has helped, as well.

Investors have taken notice. Through the end of November, the fund had welcomed nearly $16 billion in new assets and was second in inflows only to  PIMCO Total Return  for the year to date. Sizable inflows and strong performance have expanded the fund's asset base to more than $45 billion in 2010 from less than $2 billion five years ago. And, when you include assets in separately managed accounts and offshore vehicles, that number is close to $100 billion. We're always watching for the adverse effects size may have on a strategy, but, thus far, we think Hasenstab's approach is scalable.