Analysts as Portfolio Managers

Plenty of funds are managed the traditional way, with generalist managers who tap the work of analysts but ultimately call the shots for their portfolios. In addition to that model, many fund companies also offer distinct portfolios managed by their analyst research staffs. These funds typically keep sector exposures constrained to an index and allow their sector specialists to pick stocks within their respective sleeves.

By allowing analysts to run a portfolio of cold hard cash, the firms explain, they're providing a place to park their best ideas, think like portfolio managers, and be held more accountable for their picks, all of which should help strengthen the research. In addition, the greater level of responsibility can help make a career-analyst role more appealing and also serve as a retention tool.

These funds offer a unique and interesting window into the inner workings of the asset manager. For this piece, we took a closer look at the analyst-run funds offered by five prominent fund companies to see what we could learn about the investment culture within the organization as well as the analysts' tendencies and abilities. We looked at the performance of these funds and the portfolio makeup. Here's a summary:

 Janus Research (JAMRX)
Janus has undergone a transformation over the past 10 years, moving away from a culture centered on star managers and toward an environment that balances responsibility, reward, and recognition more evenly between managers and analysts.

As part of its emphasis on analysts and expansion of the team following the tech bust in the early 2000s, Janus handed management of a struggling fund, Janus Mercury, to its analysts in February 2006 and renamed it Janus Research. The fund has distinguished itself among the broader fund universe and has also given other Janus funds a run for their money. From the time the analysts took over through the end of March 2011, it has gained 5.42% annualized, placing it well ahead of large-growth peers and 0.98 percentage points ahead of the Russell 1000 Growth Index. Over that same stretch, it ranks third among Janus' seven domestic-focused funds that invest in mid- and large-cap companies. Only  Janus Twenty  and  Janus Enterprise (JAENX) have fared better.

Compared with other analyst-run funds we looked at, this one had the most distinctive portfolio with only 28% of its holdings replicating the Russell 1000 Growth Index (it overlaps even less with the S&P 500). While sector weights align with the Russell index, the analysts are free to buy stocks that aren't in the benchmark and to decide what to own within their sector teams. The portfolio's inclinations suggest Janus' high-conviction, growth-leaning culture is very much a part of the analyst DNA. Nearly 20% of assets are invested in foreign companies, none of which appear in the fund's domestic-focused benchmark. Many picks are up-and-coming mid-caps with rapid growth trajectories and healthy free cash flows such as Atmel Corporation, a semiconductor company, and  Amphenol (APH), a hardware firm specializing in connectors. Its latest portfolio doesn't include stalwarts such as  ExxonMobil (XOM),  Coca-Cola (KO), and  McDonald's (MCD), which carry significant weight in the index. The portfolio composition and its competitive performance over the past five years are strong indications that differentiated research is alive and well at the firm.

 Fidelity Stock Selector All Cap (FDSSX)
Like Janus, Fidelity also had a legacy of star managers and bold stock-picking that it has tried to balance out with a deeper, more-seasoned analyst bench and a greater appreciation of risk. Fidelity's analyst-run fund looks more like the new Fidelity than the old--45% of its portfolio at the end of 2010 directly overlapped with the S&P 500. Although not the least active of the analyst funds we examined, its portfolio looks surprisingly bland, given Fidelity's heritage as a competitive, free-wheeling, stock-picker-driven shop epitomized by one of its most influential managers, Peter Lynch.

The sector leaders managing some of the firm's Select funds pick stocks for sleeves of this portfolio, which they took over in late 2009 following years of poor performance under a prior manager. Fidelity had already upped the ante on its analyst staff several years prior in 2005, at which point it began a spending spree to expand the size of the team, hire experienced sector specialists, and encourage more to remain as career analysts as opposed to entering the merry-go-round of sector assignments that used to be the modus operandi at the firm.

The analysts still need to show their mettle here over time. The buildout hit some early bumps out of the gates, and some of the new hires, even experienced ones, didn't pan out. The majority of the underlying sector managers have only been running their sleeves since 2007 or later. Performance here has perked up since the sector leads took over in November 2009, though, with the fund ahead of the S&P 500 on their watch. The Select sector funds also have reasonably strong performance on their own, but the question remains whether putting all their picks together will add up to a good long-term record.

 Putnam Research (PNRAX)
One of Fidelity's cross-town rivals has been undergoing a transformation of its own following the hiring of CEO Bob Reynolds in 2008. Reynolds has given the equity research side of the house a real shot in the arm. That's involved turnover within the analyst and portfolio manager ranks, most of it deliberate, to address performance that was in dire need of improvement. Two of Reynold's early hires--Nick Thakore, who manages  Putnam Voyager , and Bob Ewing, who runs  Putnam Fund for Growth & Income --contributed to the revamp of the analyst staff and helped rework the firm's stock-picking strategy. Part of their plan involved shaking up the team here, hiring many new analysts and filling holes with seasoned, already-proven talent. Putnam has poached analysts who previously worked at places like Harvard's endowment, Citigroup, and RiverSource. It's unclear whether all of the holes have been filled, however. In 2010 two sector leads, one who had been with Putnam for many years and another who was only there for a couple, left the firm. In addition, Andrew Matteis, who was named the director of global large-cap equity research and led on this portfolio only a few years prior, left in mid-2010. It's unclear whether Putnam will slot its incoming director of global equity research, Aaron Cooper, into the vacancy when he joins this summer or leave the underlying analysts fully in charge.

This portfolio doesn't look very distinctive--at the end of 2010, it had a holdings overlap with the S&P 500 of 66%, which is on the high end for active funds in the large-blend category. Yet even without sticking its neck out far on individual stocks and not making bets at all on sectors, it has still managed to post a three-year return in the top 10% of the competitive large-blend category and surpass the benchmark by nearly 3 percentage points. Much of its outperformance has come from successful, measured wagers on widely held companies such as  Apple (AAPL). It has also made its mark with some nonindex picks from further down the market-cap range such as Atmel, which was a strong performer for this fund and has been subsequently sold from its portfolio.

 MFS Research (MFRFX)
MFS Research has been an analyst-run fund since the early 1990s, yet an emphasis on research has been a staple of MFS' team-oriented approach from its early days as the first mutual fund company. The fund made an adjustment to its strategy in 2003, when it became sector-neutral after its performance, along with the rest of the fund lineup's, was hurt by an overweight to and security selection within tech and telecom that had worked in the late '90s boom but was a huge detriment in the ensuing bust. That experience also bred a culture of delivering on promises, so avoiding style drift, distinguishing among its own funds, and more-steady performance have been goals.

The analyst team at MFS has been impressive on many counts since then, both in this portfolio as well as through its influence on funds offered across the firm. The research is distinctive. At the end of 2010, only 39% of its portfolio overlapped with the S&P 500. Although there can be some industry bets--for example, it succeeded in 2008 by avoiding banks in favor of insurance companies--it more regularly achieves that profile by making deliberate choices between stocks. Whereas some with an eye toward their index would merely underweight a stock they didn't like, here the analysts won't own it at all. The portfolio doesn't own index heavyweights  Microsoft (MSFT),  General Electric (GE), or  Wells Fargo (WFC), for example. In their stead, 23 of the portfolio's 126 positions aren't in the index at all, and the sector teams have stashed more than the index weighting in Apple,  Danaher (DHR), and  JP Morgan Chase (JPM).

At the heart of MFS' stock-picking approach is a longer-term orientation and a preference for higher-quality companies with strong financial positions and durable franchises. Also core to its research group is a willingness on the analysts' part to stay part of a team, as opposed to moving to the portfolio-manager ranks. On that front, MFS seems to be successful, considering turnover among the analysts is fairly limited (and the shop didn't need to reduce headcount during the most recent downturn). One other important note in developing the career-analyst track: At MFS, analysts can earn as much compensation as portfolio managers. Whatever the method, MFS seems to be doing it well: Since the Research fund adopted its sector-neutral strategy in 2003, the fund has outdone its S&P 500 Index, 6.94% to 5.61% annualized.

 T. Rowe Price Capital Opportunity (PRCOX)
Unlike some rivals, T. Rowe Price hasn't had to swoop in and bolster its research effort, but this analyst-run fund lacks the most spice from a holdings standpoint. At year-end, 73% of its holdings and position sizes were an exact replica of its benchmark, the S&P 500. Like the other funds on this list, this one operates with tight sector limits. In addition, it is also restricted from owning stocks that are not a part of the index, which makes looking active much tougher. T. Rowe's process here is certainly restrained, but its long-term-oriented approach and risk-consciousness have helped the firm make its mark over time with strong research and a willingness to diverge from the pack. It's just hard to see that by looking at the makeup of this portfolio.

Despite the fund's muted profile, its performance has been decent over time. Since taking its current form as an analyst-run offering in May 1999, it has outpaced the S&P 500 by just more than 1 percentage point per year, earned in small increments over time. Still, we've had a hard time favoring this fund over siblings such as Analyst Picks  T. Rowe Price Equity Income (PRFDX) and  T. Rowe Price New America Growth (PRWAX). Both make good use of the firm's strong analyst bench but also have a seasoned lead manager at the helm, showcasing more conviction.