Free-Range Funds That Outrun the Bear

Go-anywhere managers are in the black

No one ever called Peter Lynch a "large-cap growth" fund manager. Back in the 1980s when he was making history with the Fidelity Magellan Fund, he just bought stocks--large-cap, small-cap, growth, value, whatever. If he thought a stock would make money for shareholders, that was good enough.

Today, few fund managers have that kind of latitude. Indeed, the vast majority of funds are boxed into categories such as "small-cap value" or "mid-cap growth"--and their success is measured by beating a specific benchmark or peer group of funds, not necessarily by making money for investors. In short, a fund can have relatively good performance and absolutely horrible results. Some managers don't like that a bit. "There has been benchmark tyranny over the last few years," says Jean-Marie Eveillard, portfolio manager of the First Eagle Sogen Global Fund.

A handful of funds have managers who, like Eveillard, operate outside the box. They choose from a wide range of investments that go well beyond common stocks into everything from junk bonds to commodities and private equity. And unlike most fund managers, in the absence of good opportunities, they hoard cash. "If you're oriented toward absolute returns, you can't be confined to a narrow field of investments," Eveillard says.

Over the past three years, the talent of the managers and the flexibility of these "go anywhere" funds have really come through (table). Most have positive returns at a time when the Standard & Poor's 500-stock index fell an average of 10% per year. On the other hand, although they made money during the bull market, many lagged the indexes.

The eclectic Eveillard--he invests in stocks, bonds, cash, gold, even private equity--has delivered excellent overall results. He can boast 14.6% annualized returns over the past 23 years, and his fund has held up remarkably well in this bear market. Yet in the press and on the Internet, he was criticized in the late 1990s when he sold a good chunk of assets and went to cash. From the perspective of an investor seeking absolute returns, not relative ones, the move made sense. "Buying stocks just for the purposes of being fully invested is idiotic," says Eveillard.

Flexibility allows a manager to find the greatest values. Consider Steven Romick, portfolio manager of the UAM FPA Crescent Fund. Before he invests in a company, Romick examines the entire capital structure--its common and preferred stock, convertible debt, bank loans, bonds--to see which security offers the best risk-reward potential. He recently examined the equity and debt of beleaguered Qwest Communications (Q ) and concluded that both were worth about double their present value. But the debt had a 27% yield to maturity and more downside protection: bondholders would have a stronger claim to company assets than equityholders if the company went bankrupt. He bought the bonds. "I can create a scenario in which the equity is worth zero," says Romick. "I can't create a scenario in which the debt is."

Morningstar categorizes Romick's fund as a "domestic hybrid," a catchall group that takes in everything from funds that have strict asset allocation mandates--say, 60% stocks, 40% bonds--to those that act like hedge funds. Go-anywhere managers can wind up in any fund category or "style box," though none will truly fit. "We have a split personality," says Stephen Boesel, portfolio manager of the T. Rowe Price Capital Appreciation Fund. "Lipper [another fund tracker] calls us mid-cap value, while Morningstar labels us a domestic hybrid fund." That's because Boesel will often buy convertible bonds if they offer better value than stocks. He also buys stocks of any market capitalization.

Russel Kinnel, Morningstar's director of fund analysis, agrees that some of the best managers are hard to pigeonhole, but he says style-specific funds add value. "It can be dangerous if every manager in your portfolio is given free rein," he says. "There can be a big opportunity cost if they're all out of the right sector that rallies or in the wrong one, and you don't know it." If you like free-rein funds, Kinnel suggests using them alongside index funds, so you'll know exactly where part of your money is.

Many of the go-anywhere managers have a value slant--they like to buy cheap. But not all. Manu Daftary, who runs the Quaker Aggressive Growth Fund, cares more about earnings growth than valuations. He delivered a big 96.9% return in 1999, investing heavily in tech stocks, but when the earnings dried up in 2000, he moved more than half the portfolio into cash and started shorting stocks. "It's the profits, stupid," he says. "If earnings come back, I'll be bullish again." His cash position remains at 50%.

While Daftary says about 80% of the stocks he buys have a "growth component" to them, he's not afraid of owning traditional value stocks such as retailer AnnTaylor, which has a low price-earnings ratio of 12, and Nextel Communications, which is also cheap relative to its peers. Some value managers such as Legg Mason's William Miller dabble in growth stocks. Miller's most flexible fund, Legg Mason Opportunity, now has more than 11% of assets invested in's stock and bonds. The company has no earnings, at least as measured by Generally Accepted Accounting Principles, and has a lofty price-to-cash-flow ratio of 152.

Some go-anywhere funds--such as the Evergreen Asset Allocation and Leuthold Core Investment funds--make quantitative evaluations of entire asset classes. Evergreen's fund, previously known as GMO Global Balanced Allocation, is invested in 14 asset classes, including inflation-indexed bonds, real estate stocks, and currencies. Although their approach is different, these "top-down," or "macro," funds have the same objective: delivering absolute returns.

Evergreen manager Jeremy Grantham says the fund's makeup is almost identical to the one he manages for his sister's pension plan. "If you were running your sister's money, you'd say: `How can I optimize the asset allocation so I can deliver a safe, stable return?"' he says. "You wouldn't just try to beat a benchmark." His fund is up 5% since the bear market began in April 2000. Sticking to the U.S. stock market would have cost his sister some 40%. Fortunately for sis, her brother can invest anywhere.

By Lewis Braham

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