The Best-Managed Mutual Funds
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There are more than 6,000 mutual funds, but, hey, how many can you name? Chances are the ones you know are offered by giants such as Fidelity, T. Rowe Price (TROW ), and Vanguard.
The biggies have some fine funds, but excellence is not a matter of size. Scores of outstanding funds run by small investment management outfits fly below the radar. Ever heard of Keeley Small Cap Value (KSCVX )? What about Kinetics Paradigm? They're both among our 24 winners of this year's Standard & Poor's/BusinessWeek Excellence in Fund Management Awards. "Year after year we unearth these tiny gems," says Phil Edwards, S&P's managing director of funds research. (Standard & Poor's, like BusinessWeek, is a unit of The McGraw-Hill Companies (MHP ).)
To find our winners, we start with the 830 funds rated A or B+ in their categories for the five years ending on Dec. 31, 2006, in the BusinessWeek Mutual Fund Scoreboard (BW—Jan. 22). Our highest ratings don't necessarily go to the funds that racked up the biggest numbers. What counts are the risk-adjusted returns.
To be considered for the award, a fund must have assets of at least $100 million, a manager with at least five years' tenure, and a minimum investment of less than $26,000. It should also be open to new investors. Once a fund clears those hurdles, S&P analysts conduct in-depth, face-to-face interviews with managers to quiz them on investment practices.
In the four years since we started these awards, our Best Managers have lived up to their billing. The average stock fund finalist beat the Standard & Poor's 500-stock index by 5.6 percentage points annually. (That's two years of gangbuster stock fund performance, and two years when our stock funds were within a hair's breadth of the index.) Among bonds, our finalists handily beat the Lehman Brothers Aggregate Bond Index in three of the four years.
On the pages that follow you'll discover the secrets that made four of the smaller fund companies successful and a chart of all 24 finalists. For more information on the other 20, plus a slide show, free S&P reports, and updates on our previous winners, go to BusinessWeek.com/extras.
KEELEY SMALL-CAP VALUE FUND
To John Keeley Jr., stockpicking is more than a job. It's an obsession. "I have very few other interests, and I don't even consider it work," says the 66-year-old manager of the Keeley Small Cap Value Fund. "I intend to pass on to my eternal reward slumped over a Quotron terminal." Thirty years after starting his own research firm and 14 years after the launch of his mutual fund, Keeley remains as excited as ever about finding overlooked and underappreciated investments. During the past 10 years his fund has outperformed the Standard & Poor's 500-stock index by more than eight percentage points annually, on average.
Marketing isn't Keeley's forte, however, and his tiny business struggled in obscurity, despite his investment prowess. In 2002, almost 10 years after the fund opened, it had grown to just $65 million in assets, so Keeley decided to bring in one of his sons who'd worked in marketing at a brokerage firm. A second son, also with marketing experience, joined in 2005. The younger Keeleys started spreading the news, and made an extra effort to attend the trade shows that cater to investment advisers. Now the fund weighs in at $4 billion.
Keeley gets his edge by shopping for stocks in the inefficient corners of the market, particularly spin-offs, restructurings, and companies emerging from bankruptcy. Wall Street typically doesn't follow such outfits or include them in indexes. So how does Keeley uncover these properties? "They're pretty much in the newspaper," he says. "But no one's doing a lot of analysis on them, so it's just a question of how hard you want to work on your own."
Look at Chaparral Steel, spun off from concrete company Texas Industries (TXI ) in 2005. At the time, the stock, with a book value of $24, was trading for less than $15. Now it's over $50. "It didn't take a rocket scientist to figure out that could be a good situation," Keeley says.
This spring will likely present a bevy of opportunities for deep-value investors. That's because three big companies—Tyco International (TYC ), American Standard (ASD ), and Temple-Inland (TIN )—are splitting up divisions and spinning them off to shareholders. Keeley should have plenty to keep him at his desk.
KINETICS PARADIGM FUND
Unlike some of the other smaller fund companies on our list, Kinetics Asset Management is no stranger to the limelight. Kinetics Internet Fund (WWWFX ), which opened in 1996, was one of the first Web-oriented portfolios. The fund had a gripping story: Its young manager, Ryan Jacob, ran the business out of his mother's garage. Amid the tech run up, assets swelled to as high as $1.5 billion as the portfolio gained 216% in 1999. Then the bubble burst, and the fund lost its luster.
All of the hype and subsequent bad publicity made Kinetics' co-founder Peter Doyle press-shy. In a recent and rare telephone interview from his Sleepy Hollow (N.Y.) office, he told BusinessWeek: "We have the reputation of being technology investors, but that is not who we are. We have done so many things right."
The first is performance. Kinetics Paradigm (KNPCX ) earned a 20.3% average annual return for the 2002-2006 period. That's nearly 15 percentage points better than the Standard & Poor's 500-stock index. (The Internet Fund, which has a new manager, gained an average 6.2% during the same period, while the firm's other three funds are outpacing their peers.)
Right now, Paradigm's $2.8 billion portfolio, which has a wide berth to invest in large-, mid-, or small-cap stocks, is loaded with securities exchanges and other investment-related financial plays. "If you believe stocks, bonds, and real estate are good investments...why not own the gateways and the gatekeepers?" says Doyle. The largest current holding is the NYSE Group, which owns the New York Stock Exchange (NYX ) and is unloved by Wall Street.
Kinetics' contrarian ways caught the eye of fund analysts at s&p. Doyle's anti-herd mentality helped him establish credibility with Dino Macaluso, a financial consultant in Albany, N.Y. During a sales pitch in late 2001, Doyle told Macaluso and his colleagues that Cisco Systems would soon trade in the single digits and other tech companies would experience a serious correction. "Most people in this business paint a happy scenario," Macaluso says. "The fact that Kinetics marches to a different beat is refreshing."
THORNBURG CORE GROWTH FUND
It's called the Thornburg Core Growth Fund, all right, but manager Alexander Motola has his own ideas about what constitutes a growth company. It's not just about buying companies with rocketing revenues and earnings. Indeed, some of the fund's top stocks, like DirecTV (DTV ) and Hertz Global Holdings (HTZ ), are just as likely to show up in the portfolios of value funds. "We have a pretty flexible approach to growth," says Motola. "To us, a growth stock is one that's promising but where there may be some material misperception about the company's earnings potential."
Actually, it's not that different from the approach of Legg Mason Value Trust manager Bill Miller (a five-time winner of the fund manager award) to value investing, which includes stocks like Amazon.com (AMZN ) and eBay (EBAY ). Motola was attracted to Hertz, for example, when criticism about the company's quick return to being a public company after a 2005 leveraged buyout distracted investors from the car rental giant's strong growth prospects. "This ownership is extremely motivated now to move the stock price up," he says, noting that the LBO firms that took it private—Clayton, Dubilier & Rice, The Carlyle Group, and Merrill Lynch Global Private Equity—still own a significant chunk of the company's shares.
He's also willing to venture beyond U.S. borders. Shares of Copa Holdings (CPA ), which owns a Panamanian carrier called Copa Airlines, were languishing in the mid-20s last year on concerns about high fuel costs and a tricky takeover of a Colombian competitor. But Motola saw the company was able to maintain operating margins amidst all of the pressure. The stock has more than doubled since.
Motola's wide-ranging philosophy has rewarded shareholders with an average gain of 14% annually over the past five years, nearly double the average gain in the S&P 500. Thornburg is based in Santa Fe, N.M., far from the daily grind of major financial centers. If the markets get too chaotic, Motola calms down by slipping out of his office. "When you can look up at an 8,000-foot peak, it's more conducive to keeping your sanity," he says.
Thornburg's assets under management just about doubled last year, to $35 billion, but it's still a small company for the $10 trillion fund industry. One advantage of their size is that there's no pressure to develop lots of new funds covering hot investment areas. "Every fund here is started by the investment department, not marketing," says Motola. That's why after 25 years, Thornburg runs only six stock funds.
STRATTON SMALL-CAP VALUE FUND
Stratton Management, which runs the award-winning Stratton Small-Cap Value fund (STSCX ), is the smallest fund company on our list. Perhaps that's because marketing isn't a priority: The company's bare-bones Web site looks as if it were designed in 1996, a millennium ago in Internet time. "We are not proactive," concedes Gerald Van Horn, co-manager of the Stratton Small-Cap Value fund. "We have no marketing budget."
Indeed, when Robert Nelson, vice-president at 1st Source in South Bend, Ind., was researching small-company funds for his clients a year ago, he called Stratton for information. Nelson expected to be zapped fund reports electronically, but some printouts arrived later via U.S. mail. "That really caught my eye—no one mails anything anymore," Nelson says.
Stratton's outreach methods are fusty, but the Plymouth Meeting (Pa.) fund's returns are anything but. The total return for the five years ended Dec. 31, 2006, is 16.7%. Stratton earns a place on the list, too, because it is still open to new investors. Many top small-cap value funds are closed.
With a relatively modest $750 million in the small-cap portfolio, Van Horn says he has no trouble putting new money to work. With the help of computer screens—his investment methods are 21st century—Van Horn tries to identify unloved, undervalued stocks. Stratton's small size means more personal service, too. Have a question about a stock or strategy? Van Horn and the company's other investment professionals actually take shareholder calls.
By Lauren Young and Aaron Pressman