Funds for the Long Haul
These managers have stood the test of time for their investors
Three strikes and you're out. Investors might be forgiven for taking that advice after three consecutive down years in the market. But didn't your mother advise you that patience is a virtue? And, as long-time mutual-fund managers like Chuck Royce have proved, losing money occasionally is part of the job of investing for the really long term. Who knows where the market will end 2003? We don't, although stocks have begun the year on a positive note, spurred in part by anticipation of the $674 billion tax cut and economic stimulus plan President Bush unveiled last week. But what's clear is that if you're serious about staying the course, there are few better fund managers than the ones profiled here. And they'd be the first to tell you that opportunity is still out there amid the ravages of a three-year bear market. These men have had their bad years, for sure, losing more than a quarter of their portfolios in some cases, but the good years have outnumbered the bad by far, allowing these managers to post average annual returns that have beaten the overall market over the past three decades. Mutual fund companies are obliged to warn investors that past performance is no guarantee of the future--a message that apparently did not sink in with the masses who poured money into hot tech funds during the great bull rush--but is there any better measure of the likelihood of future success than looking at someone's long-term record of managing money?
These funds run the gamut of investing style and approach, from those that focus on small domestic companies to those that dabble in precious metals, downtrodden foreign equities, and even bonds when the times call for it, as they did last year.
PENNSYLVANIA MUTUAL
MANAGER'S BEST YEAR: 1975; up 121.1 pct.
MANAGER'S WORST YEAR: 1973; down 48.5 pct.
Chuck Royce sure picked a lousy time to become a mutual fund manager, taking over the Pennsylvania Mutual fund in late 1972. His first year out, the fund lost nearly half its value. But when you take a longer view--say, 30 years--Royce's stock-picking acumen seems pretty sharp. The fund, part of a group devoted to stocks of small and very small companies, has returned an average of 12.21 percent annually over the past three decades, despite a 9.22 percent loss last year. "The early '70s were personally a disaster," says the New York-based Royce, 63, who favors a value-oriented approach to picking stocks. "It all came out of a near-death experience."
Like most value-fund managers, Royce prefers to buy companies whose shares are trading at a discount from what might be their intrinsic worth. But price is not where Royce starts shopping. Rather, he says, "We're looking for sustained returns on capital." To determine that, he and his staff pore over company reports and meet daily with a half a dozen or so management teams. "We want to understand how they make the money," he says, and "what are their vulnerabilities."
Modesty prohibits the bow-tied Royce from touting his long-term accomplishments, but Morningstar gives the fund a five-star rating, noting that it is far less volatile than other small-company funds. "Simply said, Charles Royce has gotten the job done for `patient' investors," noted mutualinvestor.com Editor Steve Wagner last year.
Royce has done so by combing through the universe of small companies to find hidden gems like Woodward Governor, a Rockford, Ill., maker of pumps and valves for the energy and aerospace industries. Earnings at the firm, founded in 1870, have risen more than 19 percent annually on average the past five years. Another nugget is Simpson Manufacturing of Dublin, Calif., which makes specialty connectors and ties for use in the construction industry. The company has enjoyed average revenue growth of more than 16 percent annually since going public in 1994.
Royce's fund doesn't favor any one sector over another, rather focusing on the small to medium-sized manufacturers and service firms that are the backbone of the economy. They may be great investments but are often eschewed by fund managers in favor of big names like GE and Microsoft.
Royce sees a competitive advantage in being able to toil where others fear to tread. "They're more interesting companies," he says of those in his fund. "They're going to be inefficiently priced because they're not well known." And in this market of distrust, they share another value that investors can appreciate: "Smaller companies typically are simpler companies. They don't have accounting screw-ups because they're not big enough to bury them in." -Tim Smart
LIBERTY ACORN
MANAGER'S BEST YEAR: 1976; up 65.2%
MANAGER'S WORST YEAR: 1974; down 27.7%
Sit down for a chat with Ralph Wanger and you could be fooled into thinking he's paying rapt attention, taking copious notes during a dialogue that's sure to be peppered with historical analogies (the Crusades are a biggie). But the notes turn out to be a sheet of paper filled with sketches of airplanes. One looks like a World War II vintage P-47 Thunderbolt fighter, while another resembles a Soviet Backfire bomber from the Cold War.
Obviously, Wanger, 68, is a guy fascinated by times past. And he's partial to things that soar and swoop. Luckily, both traits dovetail nicely with his job as a portfolio manager who looks to history to give him some insight into the present-day nature of the markets. And considering that since 1970 he has been running his Acorn fund (which Liberty Financial bought in 2000 and renamed Liberty Acorn), Wanger has plenty of personal history to draw upon as well. "I don't expect another bull to emerge for a very, very long time," says Wanger, who speaks in a slow, muffled style. His speech is punctuated by frequent pauses that give the impression he's accessing some data archive deep in his cerebrum.
Wanger bases his perilous prediction--25 years of sideways trading wouldn't be totally out of the question--not on the current direction of interest rates or earnings or consumer spending but on a circle-of-life interpretation of market history. Stocks, he says, can cycle through periods where "an ordinary person can make a whole ton of money" without much expertise (like the 1990s). And then there are times where they don't do much for years, though investors can still "do all right if you find the right companies, although the market won't bail you out." Over time, he has found enough winners to post an average annual return of 15.37 percent vs. 11.46 percent for the S&P 500. There's little surprise as to which era he thinks we're in now. Even though the stock market finished in the red for a third straight year, Wanger says he has been given some hope by current investor psychology. "The 1970s felt different," he recalls. "There was no liquidity, no trading. It was very hard to do anything, a very depressed feeling. But now you still have people believing in technology stocks."
For his part, Wanger is looking to a few good individual stocks--slot-machine maker International Game Technology, motorcycle maker Harley-Davidson, and financial firm SEI Investments are among his top holdings. A common element in his picks: market and brand dominance. He declares Harley-Davidson "the best brand in the business," noting that "people like Coca-Cola and McDonald's, but rarely do they tattoo their names to themselves." And he thinks the times are still ripe for bonds. "In this environment, they'll be about as good as stocks," he says, with less risk. -James M. Pethokoukis
FIRST EAGLE GLOBAL
MANAGER'S BEST YEAR: 1980; up 33.2%
MANAGER'S WORST YEAR: 1990; down 1.3%
The French are known for their, shall we say, quirky tastes (Jerry Lewis, the Three Stooges, those annoying mimes). Jean-Marie Eveillard certainly lives up to his heritage. When other money managers were loading up on technology stocks during the Internet craze of 1999, this 62-year-old Frenchman instead bet big on companies such as Rayonier, a small Florida firm that supplies lumber to the construction industry, and Buderus, a German manufacturer of boilers. "Boilers and timber, you could hardly be more `old economy' than that," says the manager of the First Eagle Global fund. Call them whatever you want, they proved to be smart plays. Buderus stock rose 50 percent, and Rayonier shares stayed even over the past three years while the S&P 500 fell nearly 38 percent.
Eveillard's eclectic sensibilities didn't win him many friends during the bull market. More than half of the shareholders in First Eagle Global pulled out of the fund by the end of the 1990s, slashing its assets from nearly $4 billion in 1997 to $1.6 billion in 2000. That's despite the fact that the fund, which trailed its peers badly in the late '90s, still generated a total return of 19 percent in 1999. For those departing, it was their loss. Over the past three years, First Eagle Global has generated average annual returns of more than 10 percent, as so-called value investing has come back into vogue. In that period, the average stock fund lost about 12 percent a year. Over the past 30 years, the fund has been a top performer, generating average total returns of nearly 12 percent a year.
Eveillard, who started with the fund as an analyst in 1970 and has been leading it since the Carter administration, has a simple philosophy when it comes to managing other people's money: "We would rather lose half of our shareholders than lose half of our shareholders' money." He and Charles de Vaulx, his comanager since 1999, act like private investors, trying to judge whether a stock is over- or undervalued based on what they think a buyer would be willing to pay for the company. When they can't find solid, undervalued U.S. companies, they look overseas or go fishing for other types of assets. About a third of the fund's assets are currently invested in Western European stocks, like Buderus, and an additional 15 percent is in bonds. And well before the recent gold rally, Eveillard and de Vaulx started investing a small percentage of their assets in gold and gold-related companies. Their bond and gold investments helped the fund post returns of more than 10 percent in 2002, when the average fund lost more than 22 percent of its value.
Eveillard says that some of the battered leaders of the '90s bull market are now priced at an attractive level. Last year, he started buying shares of beaten-down media companies, Liberty Media in the U.S. and Vivendi in France. He also started buying the stock and bonds of Tyco International, whose former CEO Dennis Kozlowski has become a symbol of corporate malfeasance. Whatever one thinks of Kozlowski, "he bought what we think are real businesses," says Eveillard. Overall, he pegs Tyco's value at just over $20 a share, so he started buying the stock when it fell below that threshold, at an average cost of between $14 and $15. Since then, the stock has climbed to about $17. He also has been buying some battered telecom bonds, including the debt of Level 3 Communications and Lucent. As for telecom stocks, it may be a while before Eveillard is willing to buy. But that's OK. If there's nothing to catch in the telecom stock pond, this Frenchman is more than willing to fish elsewhere. -Paul J. Lim
STRATTON GROWTH
MANAGER'S BEST YEAR: 1976; up 39.8%
MANAGER'S WORST YEAR: 1973; down 23.5%
Despite delivering enviable returns of nearly 11 percent a year for the past 30 years, Jim Stratton' s Stratton Growth has only $38 million in assets. To put this into perspective, the Pimco Total Return Fund raked in more than $1 billion in October alone. But Stratton, 66, a soft-spoken man who comes across as more Kris Kringle than Gordon Gekko, the Machiavellian capitalist portrayed by Michael Douglas in the film Wall Street, isn't as concerned about attracting assets to his fund as he is about managing them. He lacks a single marketing person at his small suburban Philadelphia investment firm, which makes most of its money the old-fashioned way: managing accounts for institutions and high-net-worth individuals.
That suits shareholders of Stratton Growth just fine. Stratton's fund, with a low minimum investment of $2,000, has delivered positive annual returns of about 2 percent on average at a time when the overall market has been down about 12 percent annually. Over the past decade, the fund has come up with average annual returns of 10 percent, outpacing the S&P 500. While the typical fund constantly buys and sells its holdings, Stratton will hold on to some stocks, like office equipment maker Pitney Bowes, for five years or more while waiting for them to fulfill his expectations.
Patience is something with which Stratton is all too familiar. He launched Stratton Growth in 1972, and the first three months of the fund's existence went smashingly, with total returns of 14 percent. Then the 1973-74 bear market struck, leading to a decade of absolutely no growth for the S&P 500. Nonetheless, Stratton has found a way to make money for his investors in 22 of the past 28 years.
As for today's market, "do I think we're close to entering a new bull market? Absolutely not," he says. The sawtooth pattern of stock prices rising and falling, then rising and falling again, "will be with us for a long time," he says, as investors unwind the market mania of the '90s. The technology and telecom sectors must still deal with overcapacity. The way to make money nowadays, he believes, is to look for "fallen angels," strong leaders in their industries whose share prices have temporarily slumped. These are companies like healthcare firm Baxter International, whose shares have been cut in half and now trade at a price/earnings ratio of about 15. And he's not afraid of the occasional technology stock: After Hewlett-Packard shares fell from nearly $70 two and a half years ago to below $20 late last year, Stratton found it attractive, especially with evidence that the company's merger with Compaq is going better than expected. "I would love to find another three or more Hewletts," he says. Right now, he's deciding whether to buy shares of another former leader of the '90s bull market that has fallen on hard times: Home Depot. -P.J.L.
CDC NVEST TARGETED EQUITY FUND
MANAGER'S BEST YEAR: 1982; up 78.7%
MANAGER'S WORST YEAR: 2002; down 28.8%
Ken Heebner recalls lunching with some coworkers at a former firm on New Year's Eve in 1974, right at the bottom of a nasty bear market. "Everybody was totally depressed, but within the first six months of 1975, a lot of our stocks tripled," he recalls. Heebner thinks the market might again be at such a turning point--once the fog of a possible war with Iraq clears. "If you're in the right stocks, there is a significant profit to be made," he says.
Given how the funds Heebner manages have done in recent years, he needs to post some pretty hefty returns. Only his CGM Realty has outpaced the market, on average, during the past five years. That's hardly the sort of performance one would expect from someone with his long-term record. Since he began running the CDC Nvest Targeted Equity Fund in 1977, it's up an average 13.8 percent annually, compared with 12.1 percent for the S&P 500. And back at his home firm, CGM's flagship Capital Development fund (now closed to investors) has done even better, gaining 15.3 percent during that same period.
Heebner's aversion to technology stocks was his undoing during the late 1990s bull market. And when the indiscriminate selling began in early 2000, it mauled even his mundane holdings. "We had a bubble, which I did not participate in, and now we have a bear market which is difficult to work in," he says. Even his huge stake in home-building stocks--a quarter of his portfolio--during a housing boom hasn't helped as much as expected. "They have dramatically outperformed the earnings estimates, and they still haven't done well," he says. "But you have to buy these stocks before people decide the outlook is decent." He points out that his current favorites, including Lennar, Ryland, Centex, NVR, and Hovnanian Enterprises, are growing at more than 20 percent a year, yet trade at five to six times next year's earnings. As investors realize that the recovery is real, he says, those compelling valuations are going to attract plenty of cash. But Heebner sees more than improving valuations, noting industry consolidation that allows the bigger companies to gain market share. Another plus: a wave of first-time immigrant buyers.
A big gamble? You bet. But it's one Heebner is more than eager to make. As CGM's corporate logo, a fencer in the ready position, would put it: En garde! -J.M.P. -Tim Smart, James Pethokoukis and Paul J. Lim
This story appears in the January 20, 2003 print edition of U.S. News & World Report.