These Top Funds Are Beating a Tough Benchmark This Year

In 2009 and 2010, beating the S&P 500 was a layup for most mutual funds. Small- and mid-cap stocks outperformed large caps, so actively managed funds needed only to underweight the index's biggest constituents to edge past it.

The tables have turned thus far in 2011, though, as the index's complement of large-cap stocks--many of which offer robust dividend yields--have trumped smaller and more speculative names in a jittery stock market. The S&P 500 index and the many funds that track it have proved embarrassingly elusive for many active managers. In fact, just 20% of actively managed diversified domestic-equity funds have managed to best the index for the year to date through early December.

To help shine a light on worthy funds that have managed to beat the index this year, I turned to Morningstar's  Premium Fund Screener. I started with the universe of distinct portfolios of nonspecialty domestic-equity funds, focusing on those that had earned a higher year-to-date return than  Vanguard 500 Index (VFINX). (I used the fund, not the index, as the benchmark because the index itself doesn't have expenses and it's not an actual investment option.)

To home in on the worthy offerings within this subset of top short-term performers, I used Morningstar's new Analyst Ratings for funds, screening for those funds that rate a Silver or above in our new system. Premium users can click  here to view the screen's complete output, and below I've spotlighted three of the most noteworthy options.

 Sequoia (SEQUX)
Folks, please don't make the same mistake with this fund that so many investors made with  Fairholme (FAIRX), buying it with the expectation that its extremely strong recent returns will continue. That said, Sequoia's year-to-date performance is head and shoulders above that of the other funds that made our list. Interestingly, the fund's portfolio doesn't include supersized weightings of the S&P 500's best-performing positions but instead looks quite distinctive;  Valeant Pharmaceuticals (VRX),  Fastenal (FAST), and  TJX Companies (TJX) have been among its biggest winners. For investors who buy the fund with the understanding that the portfolio's distinctive look could work against it at various points in time, Morningstar analyst Kevin McDevitt thinks there's a lot to like here, scoring it well on four of the five pillars that contribute to its Analyst Rating. (The one knock against the fund is its expense ratio; at 1% it's hardly egregious but could be lower, particularly considering the growth in the fund's asset base.)

 Vanguard Dividend Growth (VDIGX)
This offering seems to pop up in any number of screens that I do, whether I'm looking for dividends or good stewardship. Happily for shareholders (and us), its performance over both the short and long term has vindicated our repeated recommendations of it. Owing to its focus on financially stable companies with a history of raising their dividends, it has held up like a champ alongside other funds during periods of economic and market uncertainty. The financial crisis was a good stress test; though the fund lost one fourth of its value in 2008, that was 10 percentage points less than how much the S&P 500 lost during that year. It has also thrived during 2011's volatile market, with positions like  Automatic Data Processing (ADP) and  International Business Machines (IBM) contributing outsized gains. Morningstar analyst Dan Culloton thinks the fund looks good on a going-forward basis, too: It has a seasoned manager in Donald Kilbride of Wellington Management, a sensible process, and ultralow costs for an actively managed fund.

 Yacktman (YACKX)
Although this fund has had its share of winning holdings this year--number-two name  News Corp   key among them--what it hasn't owned has been essential to its success, too. Specifically, the Yacktman team generally downplays economically sensitive companies in the industrial and natural-resources sectors and has also maintained a very light stake in financials, by far the worst-performing sector of the year. Instead, management's focus on businesses with stable cash flows, primarily in consumer industries, has held it in good stead in a skittish economic environment. Like the aforementioned funds, Yacktman and sibling  Yacktman Focused (YAFFX) won't always look this good; Yacktman's style went wildly out of favor in the late 1990s, for example. But those who share management's long-term mindset will find a lot to like here.