The Best Mutual Funds
If there's one thing investors want in a mutual-fund manager, it's the ability to make money. Unfortunately, that talent has been hard to find lately. The returns that hot-growth managers produced in the late 1990s are long gone. And even conservative managers who have weathered the three-year bear market better than most are limited to bragging about losing less money than the market averages.
It makes you wonder whether any manager can still turn a profit. Thankfully, the answer is yes. Here in the 18th edition of BusinessWeek's Equity Fund Scoreboard is where you'll find the best that the industry has to offer. This tenacious bunch has done well in both the best and worst of times. From a database of 3,458 stock funds, we've identified the select few with five-year records that earned the best returns for the least risk. The list is short: Only 172 funds earn our overall A rating. Others get a top grade as the best in their category.
Although they may not be the leading performers in any given year, the A-rated funds have the best returns relative to the risk they took over the long haul and make good choices for buy-and-hold investors. We adjust the pretax returns of all the funds for the amount of risk their managers took to achieve their results. For each of the past 60 months, we check whether a fund beat the risk-free return on Treasury bills. Each time it fails, it earns negative marks. The bigger the sum of negative numbers, the higher the fund's risk of losses.
Results for the 605 largest funds start on page 62. Ranging from the $61 billion Fidelity Magellan Fund to the $511 million Mercury International Fund, they represent almost 90% of the assets of all the funds in our database, which is available in its entirety at http://bwnt.businessweek.com/mutual_fund. The online returns--and BusinessWeek's ratings--are interactive and updated monthly.
The Scoreboard, prepared for BusinessWeek by Standard & Poor's, contains a wealth of detail about each fund. For instance, we highlight cash holdings, which gauge how much faith managers have in the U.S. stock market or their particular sector. Lots of cash means the manager is finding few buying opportunities. For instance, Zack Shafran, manager of the $1.7 billion A-rated Waddell & Reed Advisors Science & Tech Fund, has been so cautious at times that he has parked north of 40% of his fund in cash, earning him high marks: The fund is up 12% annually since the start of 1998, while peers have lost an average of 1.7%.
The Scoreboard will also alert you to manager arrivals and departures. These are crucial because future performance may fall off after long-standing star managers leave. For example, if you're thinking about adding to your stake in the highest-performing A-rated fund, the Schroder Capital Ultra Fund, it's important to know that manager Ira Unschuld, who has managed it since its late-1997 inception, left in December to start his own investment firm. Unschuld's average annual 72% gain over the past five years was achieved with a hedge-fund-like strategy of betting that stocks would fall by shorting them. It's a style not easily replicated by other managers, who usually prefer to hold long positions.
It also helps to know which funds make big, concentrated bets on individual stocks. For the A-rated Kinetics Internet Fund, that strategy was a calculated risk that paid off. By contrast, the White Oak Growth Fund earned a D rating for putting too much money in too few stocks that were poor performers. You can find that information in the Scoreboard, which gives the percentage of assets accounted for by a fund's top 10 stocks.
Top-rated managers are a cautious lot--they don't speculate wildly on the market or chase after hot performers. "I don't want to take so much risk that I'm No. 1, because that means I'm also taking the risk to be the last in the group," says Jerome Heppelmann of the A-rated PBHG Mid Cap Value Fund, up 11.2% annually over five years. Many of the best have a value slant--they like to buy cheap. But Manu Daftary, who runs the A-rated Quaker Aggressive Growth Fund, says that he cares more about profit growth than valuation. He's recently picked up General Electric and Citicorp. "For blue-chip, franchise businesses," he says, "they got as cheap as they've been in a long time."
Some of the best managers find better investing opportunities abroad. Like rivals with a domestic focus, many never bought into the tech-stock fad and have used the same contrarian approach in foreign markets. "Our performance hasn't come from buying ZippidyDoDa.com," says David Winters, who manages the $950 million, A-rated Mutual European Fund, one of Franklin Resources Mutual Series funds, with $21 billion in assets. "We're traditionalists." The fund instead focuses on conservatively financed companies, such as ACF, a Spanish commercial construction company. "If you are like I am, somebody who doesn't do what the crowd does, there are times when you don't look terribly swift," says Winters, whose fund was out of favor during the bull market, though it has a five-year annualized return of 9%.
Holding a diverse group of stocks has helped most of the A-rated managers smooth out the bumps. It's a tried-and-true strategy, whatever the market conditions. "I probably sleep too well," admits Fidelity Investment's Joel Tillinghast, manager of the A-rated Low-Priced Stock Fund, which has a five- year annualized 8.3% return. "That's one of the benefits of being widely diversified." Tillinghast has held many of his current stocks for a long while, including business back-office outsourcer Affiliated Computer Services and Renal Care Group, a dialysis outfit. Both companies control large shares of their markets and have steady recurring revenues and profits. Tillinghast, who launched the fund on the eve of the 1990 bear market, says that's important in iffy times. Tillinghast is also unafraid of holding cash, sometimes as much as 20% of the fund's $15.5 billion in assets.
Sector funds that make the A-list are also dominated by managers who buy and hold, such as David Ellison of the FBR Small Cap Financial Services Fund. Small regional banks, including Quaker City Bancorp, Washington Federal, and FirstFed Financial, have been among his top holdings for years. "I don't tend to move things around too much, because there hasn't been a lot of change in their businesses," he says.
But what earns our A-rated managers the highest praise is their ability to perform well in both bear and bull markets. They do that by both having a tempered approach when growth stocks are all the rage, and a willingness to take on additional risk when their peers are running scared in a bear market. "We've been able to navigate the volatility by being extraordinarily disciplined," says Mellody Hobson, president of Ariel Mutual Funds. "We don't get caught up in the hype or affected by the doom and gloom." Stan Majcher of the A-rated $146 million Hotchkis & Wiley Mid Cap Value Fund is gobbling up such tarnished stocks as Computer Associates, Aetna, Sears, and Centex Homes. "Other people may not be comfortable with these stocks, but we are," he says. "We think a lot of the worries have been priced in."
All the same, they're more at ease now that the tech bubble has burst. Since many of the best managers exercise strict discipline and sell stocks when they hit their price targets, they now trade less and hang on longer to the gems they find. "I like these markets better," says Merrill Lynch Global SmallCap lead manager Kenneth Chiang, who took over the fund in 1998. "It's a lot more comfortable for me where we have the luxury of time." While much of Chiang's 11.6% annualized return has come from U.S. companies, he tends to spice his returns by buying some stocks in out-of-favor emerging markets. He's got 12% of the fund's assets in such stocks now, including Brazil's AmBev brewery and Indonesia's Gudan Garam, a clove-cigarette maker. "We buy when nobody wants anything to do with the country," he says. "Anyone can buy Coke or Unilever."
Going against the grain is inbred in these managers, and that helps in a bear market. But so does being opportunistic, which gained them rewards in the bull market. Soon after Jonathan K. Simon, manager of the A-rated J.P. Morgan Mid-Cap Value Fund, launched the fund in 1997, he was trading in and out of stocks more than he would have done ordinarily. Now, he's back to buying and holding the likes of Outback Steakhouse, Golden West Financial, and Kinder Morgan for their heavy insider ownership and excess cash flow. "These are companies whose founders are still around," he says. "Their mind-set is they don't care about stock price in the short term. They want to make sure the value grows over time."
It's that kind of patience that makes for good investments. And good fund managers. Now it's your turn to take some time and do your own research on the best mutual funds in the industry, with the help of this BusinessWeek Scoreboard issue. Stay tuned next week for the best bond funds.
By Mara Der Hovanesian in New York