SAN FRANCISCO – Do volatile times in the stock market call for extreme measures from fund managers? Not necessarily.
Some managers are able to capture much of the gains in good times without suffering devastating losses in down markets by sticking to a level-headed strategy through different cycles. The key is managing risk.
Here is a look at five funds run by veteran managers that won't churn your stomach, but will juice your returns even in these uncertain times:
1. Fairholme Fund
Bruce Berkowitz, Larry Pitkowsky and Keith Trauner say they try to keep investing simple. The Fairholme Fund (FAIRX) co-managers hunt for bargains and only invest their shareholders' money alongside companies led by talented management teams or individuals.
"We also like to see managers at our companies with skin in the game," said Pitkowsky.
Sticking to basics helps to explain why the duo has been able to do so well in rising markets. In the past five years, the fund's 17%-plus average annualized return bests 70% of midcap blend funds, says Morningstar Inc.
The fund buys stocks of all sizes. As a result, it's often viewed as a midcap core portfolio, although it has more assets in larger-cap names these days. Also, some 25% of its holdings heading into June were international companies.
"We do not attempt to avoid or minimize volatility," Pitkowsky said. "We actually like it in share prices. It may give us a chance to buy something for less than it's worth."
Still, its long-term volatility is running at a rate that's roughly a quarter of the fund's closest benchmarks.
The trio runs a compact portfolio which at last reporting through May held 24 different names. Investing in companies they know well allows the managers to gain personal insight into particular markets and businesses, Pitkowsky says. That also helps to keep turnover low, which currently runs around 20% a year.
"What we're focused on is not losing money," Pitkowsky said. "Buying cheaply related to free-cash flow helps us to avoid permanent losses of our clients' money."
At any given time, it's not unusual for the fund to hold 20% or more in cash. "Our cash holdings to date haven't been a drag on performance," Pitkowsky said. "It has actually helped the fund to deploy cash opportunistically."
2. Third Avenue Value Fund
Manager Marty Whitman buys stocks he considers safe and cheap. He also scans the globe for names he likes for Third Avenue Value (TAVFX) . And he doesn't limit his portfolio to any certain market-cap size.
"It's a true go-anywhere fund," Kerry O'Boyle, a Morningstar analyst, said.
In the past, Third Avenue Value has slanted heavily to small-cap stocks. But that has changed as the 82-year-old Whitman slowly shifts the portfolio to larger stocks. He points to increasingly attractive valuations for large-cap blue chips.
More than 60% of its assets were in that slice of the market heading into May, almost double what the fund invested in large-caps in early 2005.
Whitman is a master of so-called deep value investing. He combs through financials of deeply distressed businesses to come up with long-term winners. But he doesn't try to hide misses.
Third Avenue Value's shareholder letters are renowned for their candid and insightful reviews of what worked and what didn't each quarter, O'Boyle says. "It's some of the best investment literature out there by one of the best mutual-fund experts on deep value investing," he said.
His fund rarely is a chart-topper. Still, it's good enough to whip 84% of its rivals in the past decade. Over five years, Third Avenue Value's returns were better than 88% of its competition, says Morningstar.
Buying at discounts of at least 20%, downside risks are reduced. But it also means Whitman usually holds onto names longer than his peers. The fund's average annual turnover rate now is about 7%. That rivals many index mutual-funds.
Whitman doesn't just stick to stocks. He'll also buy some bonds and isn't shy about stashing substantial amounts into cash when bargains aren't to be found.
"There are a lot of value-minded managers out there, but few have done it as consistently well for as long as Marty Whitman," O'Boyle said. "As markets go through cycles, he finds bargains in different places. But his style never changes."
3. Jensen Fund
This fund's fondness for megacap stocks has held it back in recent years. So has its growth-style of investing. But both appear poised for improvement after years of neglect. If history is any indication, Jensen's time to shine is coming soon.
In bullish times such as the late '90s, Jensen Fund (JENSX) notched returns in the top 1%-2% of large-cap growth managers. That hot streak continued in the tech wreck years as racier portfolios swooned.
In the past few years as more speculative businesses such as energy and tech have ruled, the fund has fallen behind. It has virtually no holdings in either, or utilities and consumer services, some other hot areas of the economy.
Instead, Jensen's team of managers load up on proven long-term leaders. They churn portfolios at miniscule rates and follow a disciplined, well-honed approach. That includes requiring candidates for their portfolio to produce at least 10 consecutive years of 15% or better returns on equity.
"When a company reaches that mark, we found that they tend to have sustainable competitive advantages in their industries," said Robert Millen, a Jensen Fund co-manager.
The team also develops its own analysis of an operation's intrinsic value. Their aim is to buy stocks at 30%-plus discounts to current market valuations. "It helps us provide greater protection on the downside," Millen said. "That's why our portfolio has low volatility and performs better than the market in down periods."
A stormy July is a case in point. While the market was down close to 4% in the month, Jensen Fund lost less than 2% in total returns.
"We definitely invest in growth companies. However, often times it looks like we invest in value stocks. We're conservative growth investors," Millen said, pointing to a 10-year performance record that Morningstar estimates beats 91% of its peers.
"This portfolio doesn't really fit into any single category very well," Millen said. "We're focused on owning proven long-term winners, no matter how they're viewed at any given time as more value or more growth types of stocks."
4. Neuberger Berman Fasciano Fund
This small-cap fund (NBFSX) has had only one down year in two decades. That was in 2002 when it lost 8.7%. At the same time, the typical small-cap growth fund fell more than 20%.
"We call ourselves a core fund. But we definitely want growth with the businesses we're buying. It's just that we're looking for businesses that can double earnings in five years." Fasciano said. "We're taking a longer-term view with businesses that can produce sustainable growth rates."
Usually his portfolio will hold lots of stocks with annual earnings in the 15% range or slightly higher. That compares to more aggressive growth managers that shoot for twice as much.
He sticks to easy to understand businesses. "We're more generalists in nature so we tend to steer clear of tech and other more specialized companies," Fasciano said.
The 75-stock portfolio is heavily weighted in industrials. It had about 40% of total assets in that area. The fund's benchmark Russell 2000 index had some 16% in industrials.
"While some of our industrials are very cyclical, most are commercial services and transportation types of companies," Fasciano said. "These are niche, unique types of businesses that manage costs through economic cycles and take a leading position in their industries."
The strategy has worked over time. His fund has whipped its small-growth benchmark in the past 10 years by better than a 3.7 percentage point average annualized gain, says Morningstar.
Fasciano is putting up strong numbers while crafting a portfolio generating some 25% less volatility than the Russell 2000 Growth Index.
"We don't invest in anything that's not already profitable," Fasciano said. "And we weed out shaky balance sheets. We want to understand why these companies are profitable before making any investments."
5. Royce Special Equity Fund
Charlie Dreifus has been managing small-cap stock portfolios for more than three decades. In that time, he's seen markets climb and markets crumble. As such, he doesn't trust giddy, euphoric periods like 2003-2005.
"We stay away from companies with slight to no earnings and questionable business models," Dreifus said.
But those were the types of businesses investors were flocking to in the heydays after three tough down years. It didn't come as a surprise, then, when Royce Special Equity Fund (RYSEX) underperformed its small-cap core peers.
But step back and look at its returns in different cycles. In 2002 at the tech wreck's zenith, the fund outperformed 99% of its rivals. This year, its returns are topping 96% of its class with 25% less volatility.
Dreifus focuses on a few basic principles. One is to buy stocks that are cheap on an absolute basis. He calculates that by using very conservative merger-and-acquisition valuation formulas. "It eliminates any market hysteria or speculation," Dreifus said. "I'm looking for companies that can stand on their own business merits at any given point in time."
He also demands companies with clean financials and produce strong free cash flows. "These tend to be names that might be off other peoples' radar screens or industries out of favor," Dreifus said.
Since his screening weeds out turnarounds, the portfolio has shown a history of preserving capital during market downturns. "Beta is often identified with companies with big expectations," Dreifus said. "Stocks with greater betas react more because of that built-in premium by the market in general."
People have told him the portfolio "is basically operating like it's in a coma," he says with a laugh.
"These are stocks which don't have a lot of expectations around them," Dreifus said. "And most people are looking for some sort of catalyst. But if a company is attractively run and generates cash and is inexpensive as a business, it doesn't have to be sexy."
At the same time, the fund tends to lag in up markets. "The value added of this portfolio isn't in up markets. It's in down markets through preserving or enhancing capital," Dreifus said.
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