For a growing number of investors, actively managed mutual funds seem like dinosaurs. The active funds are expensive and lag the benchmarks, say proponents of passive investing. Confronted with a top-performing active manager, the critics shrug and argue that the great returns could be due to luck. Just because an active manager shined for the past five years does not mean that he will succeed in the future.
Many academic studies support the use of index funds. On average, actively managed funds do poorly. But there are clearly some outliers. A number of active mutual fund companies have been enormously successful for long periods. The records are so compelling that it is hard to attribute the success to luck. Instead, the winning results must be due to strong corporate cultures that develop successful teams of managers.
Consider T. Rowe Price. At the end of October, Morningstar showed that the company had 35 active equity funds with 10-year records. If luck determined everything, then you would expect that 50 percent of the funds would have been in the top half of their categories, and 50 percent in the bottom. But 31 of the T. Rowe Price funds delivered above-average returns. Funds that finished in the top 20 percent include T. Rowe Price Blue Chip Growth (TRBCX) and T. Rowe Price Small-Cap Value (PRSVX). The strong results should not be surprising to fund industry watchers who have long praised T. Rowe Price for its culture that limits risks and avoids fads. Relatively low expense ratios also helped returns.
Another risk-averse performer is American Funds, which landed 13 of its 14 equity funds in the top half. The company has operated strong funds since the 1930s. In a recent report, American Funds compared its long-term performance to the benchmarks. Funds that outdid their benchmarks during all 30-year rolling periods include American Funds Fundamental Investors (ANCFX) and American Funds Washington Mutual (AWSHX).
Like American Funds, Dodge & Cox boasts a winning record that goes back decades. Since 1965, Dodge & Cox Stock (DODGX) has outdone the S&P 500 by a wide margin while recording much lower volatility. All three of the Dodge & Cox stock funds with 10-year records are in the top quarter of their categories.
American Funds and Dodge & Cox are especially noteworthy because of the length of their records. But there is a considerable list of other fund companies that have beaten the odds, including Baron, MFS, Mutual Series, and Oakmark.
Track record: Five out of five equity funds topped the 10-year category averages. Notable performers: Baron Growth (BGRFX), and Baron Asset (BARAX). Strategy: Founder Ron Baron developed a brand of growth investing that aims to deliver consistent returns. Instead of looking for high flyers, the Baron managers seek companies that can grow steadily for years. The idea is to find undervalued stocks that can double in five years. Many holdings occupy unique niches and collect reliable revenue streams. “We want companies that have a significant opportunity to expand their earnings because of competitive advantages,” says Andrew Peck, portfolio manager of Baron Asset.
A favorite holding: Peck likes Gartner, which provides research on hardware, software and technology products. Clients pay annual fees for reports and access to analysts. The information is particularly valuable for corporate IT executives who have responsibility for purchasing technology products. With demand growing steadily, Gartner can raise prices regularly.
Track Record: 24 of 28 equity funds topped the averages. Notable performers: MFS Growth (MFEGX), and MFS International Diversification (MDIDX). Strategy: The portfolio managers rely on a large team of analysts who favor high-quality companies. “We want to own businesses that will be around five or 10 years from now,” says Eric Fischman, portfolio manager of MFS Growth.
The MFS managers avoid pricey stocks. Instead of swinging for the fences, Fischman and his colleagues aim to deliver steady annual performance that is consistently a bit above average. For the past 10 consecutive years, MFS Growth has finished in the top half of large growth funds.
A favorite holding: Fischman owns American Tower, which leases antenna space to wireless service providers. Revenue is predictable because the company has long-term contracts with built-in annual price increases.
Track record: Five of six equity funds topped the averages. Notable performers: Mutual European (TEMIX), Mutual Quest (TEQIX). Strategy: Diehard value investors, the Mutual Series managers aim to find stocks that are undervalued by at least 25 percent. To hold down risk, they seek companies with healthy balance sheets and cash flows. “We like situations where there is significant upside potential and limited downside risk,” says Mutual European portfolio manager Philippe Brugere-Trelat.
When they can’t find bargains, the fund managers hold cash. The cash and cautious stock picking helped the Mutual Series funds to be relatively resilient in downturns. Mutual European outdid 98 percent of European stock funds during the turmoil of 2008.
A favorite holding: Mutual European owns Kingfisher, which operates home improvement retailers in the U.K. and France. As sluggish European housing markets rebound, margins should improve.
Track record: Six of six funds topped the averages. Notable performers: Oakmark Equity & Income (OAKBX), Oakmark Select (OAKLX). Strategy: The portfolio managers favor controversial stocks that sell for 30 percent less than their fair values. Holdings must be healthy businesses that can increase their value over time. “Most of our companies have high returns on capital and strong balance sheets,” says Colin Hudson, a portfolio manager of Oakmark Equity & Income.
It is no accident when two Oakmark funds own the same stocks. The company’s analysts assemble a list of about 150 stocks that are approved for purchase. Portfolio managers must take names from the list. Managers can hold concentrated portfolios, betting heavily on a few favorite stocks. Oakmark Equity & Income owns about 50 stocks.
A favorite holding: General Motors, which trades at only eight times forward earnings. Hudson says that GM cut costs sharply during the bankruptcy process. The new truck lineup is selling well.