Where Three Mutual Funds Are Finding Bargains

Ariel's John Rogers, David Herro at Oakmark, and Marsico Funds' Tom Marsico see opportunities even as their portfolios are down drastically

Investors are yanking their money out of mutual funds at record rates. As of Oct. 31, stock funds experienced net outflows topping $195 billion in 2008, according to the Investment Company Institute. In 2002, the only other year since 1990 with negative flows, $28 billion was pulled out. How do formerly high-flying fund managers plan to claw their way out of deep holes and regain the trust—and assets—of investors?

John Rogers of Ariel Fund (ARGFX), David Herro of Oakmark International Fund (OAKIX), and Tom Marsico of Marsico Focus Fund (MFOCX) are among the managers tackling that challenge. All have good long-term records and all suffered big net outflows in 2008, according to Morningstar (MORN): a drop of $1.03 billion through last November for Ariel, $2.14 billion for Oakmark, and $616 million for Marsico.

Far from retreating into a defensive crouch, though, these managers are busy plotting comebacks. While many battered fund managers are keeping mum about their plans during this chaotic time, Rogers, Herro, and Marsico shared strategies that range from focusing on companies likely to emerge from the crisis with greater market share to picking stocks that stand to benefit from an eventual jump in consumer spending. These are longer-term bets: Many managers expect a horrible one to two years, says Russel Kinnel, Morningstar's director of mutual fund research. But, he adds: "Even the most skeptical, bearish managers are saying this is one of the best buying opportunities they've ever seen."

Been There, Survived That

Rogers, 50, doesn't sound like a manager whose $1.1 billion fund is less than half the size it was a year ago. In his third-quarter shareholder letter he wrote: "In the recent market collapse, most see red, we see green—the color of money." That may sound overly confident, but Rogers, who has managed Ariel since its 1986 debut, says he's been here before.

Following the 1987 crash, Ariel, which focuses on small and midcap stocks, gained 44% over the subsequent 12 months, nearly double the 23% rise of the Standard & Poor's 500-stock index. A stock Rogers bought in the '87 crash, Sanford, a maker of office products, including Sharpie markers, was up 91% a year later. (Sanford was acquired by Newell in 1992.) Rogers still owns it, via Newell Rubbermaid (NWL): "Pens run out of ink, and people go back and buy them again and again."

Despite obvious differences between now and 1987, Rogers says the equity markets are similar. He explains that this time around, leveraged bets, combined with a falling market, forced waves of selling. In 1987 it was computer programs that purported to provide "portfolio insurance" by hedging with index futures that deepened the decline. Now, stocks Ariel owns are trading at a 55% discount to private market value—Ariel's calculation of what a private buyer would pay for a company, vs. how the stock market values the company—the biggest discount Rogers has seen. So bad news is already baked into prices, he says.

That's why Rogers is doing what he did in 1987: "lightening up on expensive stocks to buy bargains." In a way, he says, redemptions have been a "good kind of spring cleaning." How's that? "When you're on a tightened budget, you're scrutinizing everything to make sure your portfolio is getting the best bargains," he says. He likes battered financial services, consumer, and media stocks. Such companies as Janus Capital Group (JNS), Energizer Holdings (ENR), and Gannett (GCI), he says, "are doing the right things [now] to cut costs so that when the economy recovers, they'll be lean and mean." Since its Nov. 20 low, Ariel is up 24%, buoyed by Janus's 29% gain and Energizer's 58% rise.

Eye on Market Share

Oakmark International's Herro, 48, has had a rough ride in the past few years. From 2003 through 2006, Oakmark International's average gains exceeded 25% a year. But the $2.8 billion fund's recent performance has been "lousy," Herro says. One reason he cites: adding financial-service stocks in late 2007.

Herro also has been doing some clearing out lately. One company that got the boot was Barclays (BCS), which he had bought within the past year. Herro concluded Barclays would be no better off coming out of the crisis than it was going in. "You not only have to make sure the companies you're invested in are going to survive, but that they come out with more market share," he says.

One such company that should do well, he says, is Signet Jewelers (SIG). "It's gaining share [in areas] where a lot of mom-and-pop shops are closing," he says. The company renegotiated rates on its small amount of debt before the crunch, so it's in a good capital position relative to its peers, Herro says.

He's also watching energy and emerging-market stocks, though not making broad market calls. The way to make money, he says, is on a stock-by-stock basis, with companies that have strong balance sheets and proven business models. Two he likes: BMW (BMWG.DE) and luxury holding company LVMH (LVMH.PA).

A realistic average annual gain for his fund, Herro figures, would be in the low double digits, partly because he expects lower returns from emerging markets. "A year ago, if you looked back, you saw artificially high rates of return," he says. "Now you see artificially low rates. But most of the adjustment has taken place."

MacBooks and Big Macs

Tom Marsico, 53, of Marsico Capital Management, is also bargain-hunting. Stocks are as cheap as he has seen in his 30-year career, he says. Marsico thinks rebuilding consumer confidence is the key to seeing the market improve. Since November—when the Federal Reserve announced plans to buy bad mortgage debt from government-sponsored enterprises—he has reduced the cash in the $2.5 billion Marsico Focus Fund from as much as 20% to low single digits. In the next four weeks, the fund gained 16%.

Marsico favors big companies, such as McDonald's (MCD), that hold major market share in industries with high barriers to entry. Lately he has added to his stakes in Wells Fargo (WFC) and U.S. Bancorp (USB), both of which he believes will benefit as the period of weakness in housing nears its end. He also likes Visa (V), MasterCard (MA), Apple (AAPL), and Target (TGT). He figures lower gas prices and mortgage rates, combined with economic stimulus, will boost consumer spending.

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