A lot of mutual fund columns start out by asking what your investment goals are. Are you perhaps shopping for a fund that will grow at a particular rate over a certain number of years so you can send little Ashley to college a decade from now? Or maybe you just need to take the edge off those monthly car payments.
Then they'll say something like: Here's a nifty fund that follows a value or growth-oriented investment style, has a good three- or five-year track record and even has the Morningstar seal of approval -- and leave you thinking it's the healthiest thing since sliced tofu. That is, if you haven't dozed off on your futon and dropped your Kindle by then.
Well, I say wake up! That's no way to help you pick a decent mutual fund. It barely gets you past the supermarket shelf of the 401(k) provider, broker, financial adviser or insurance firm to whom you've no doubt entrusted a juicy morsel of your life savings. And it certainly won't give you the clarity you need to make a critical decision that, if flubbed, could make you hate yourself a few years later.
A Better Way
Here's where my new Fund Focus column on DailyFinance comes in. I'm going to take a somewhat harder but far more instructive approach to finding out if a mutual fund is a worthwhile investment. And that's to examine its investment strategy -- through the eyes of the portfolio manager who actually runs it.
Sure, the manager will have a standardized investment style, whether it's large-cap value or small-cap growth, high-yield bonds or core fixed income. And his research process may impress. The fund may have an in-house team of "bottom-up" or "fundamental" analysts who spend half of their time visiting companies the fund owns. Or the analysts might be chained to their desks, using "quantitative" or "computer-driven" research that relies on customized software to predict stock prices.
But that's only part of what you need to know. It's only when you take a portfolio manager's perspective that you really start to understand that how well he executes his strategy makes all the difference. In the end, that's what distinguishes a great mutual fund from mediocre ones that claim to follow an identical strategy.
It's not just the fund's investment style and research process. It's how the manager actually picks stocks and bonds. Ultimately, it's how well he understands certain companies that are widely misunderstood that allows him to buy them for less than the market will pay later, year after year.
Getting Managers to Talk -- Honestly
You usually don't see mutual funds covered this way, but that's how I'll do it in Fund Focus. This is a lot harder than taking the usual approach of chasing funds based on their past performance according to fund-rating outfits like Lipper and Morningstar, and hoping those picks will put your hard-earned money to work gainfully over the next three or 30 years.
It's not so easy to sit down with a portfolio manager and get him to reveal how he executes his strategy -- if he's willing to tell you anything at all. Getting a money manager to open up involves him not only bragging about how often he gets it right but also admitting how frequently he gets it wrong. Mutual funds are required by law to tell the Securities and Exchange Commission which stocks and bonds they own four times a year, but those disclosures are only snapshots. No portfolio manager is required to tell you why he bought those securities, on what date he bought them, how much he paid for them, or when, and for how much he wants to sell them.
In fact, chances are you'll never have that conversation with a portfolio manager. But as a financial journalist covering money-management firms from my perch in Brooklyn, N.Y., I have that conversation all the time. In Fund Focus, I'll share my insights every week in plain English without the excruciating jargon that plagues many investing columns. (Of course, the column's name just happens to be a technical term for the market segment where a mutual fund's assets are concentrated.)
Week after week, the column will focus on a different fund manager and discuss how he executes his strategy. Most of these funds are priced at street level with low fees and low minimum deposits. Some of them have stayed below the radar because they have merely millions of dollars in assets instead of billions. Or their track record might have what some people would consider a blemish, such as a past period of crummy performance or a recent change in managers.
For example, we'll look at large-cap value equity funds that have been ignored since getting submerged by big bank stocks during the financial crisis but are now swimming back to shore faster than their peers. One such fund is the Hotchkis & Wiley Diversified Value Fund (HWCAX), which surged 97.3% during the 12 months through March 3. We'll also look at small-cap equity funds that were overlooked partly because the small companies they own are illiquid and hard to predict. One of those is the Aegis Value Fund (AVALX), which soared, incredibly, by 181.9% during the same 12 months. And we'll look at even more obscure ones like the Matthews Asia Small Companies Fund (MSMLX), which is up 136.33% during the same year even though it doesn't have an office in Asia.
No one could have predicted the astounding returns that these relatively unknown funds have achieved over the past 12 months. During the same period, the Standard & Poor's 500 index was up 64.3% -- a steep rise, to be sure, but not nearly as a great as those three funds. So, if you take the time to understand how portfolio managers execute their strategy, mutual funds can give you the power to put some of your savings to work with a big payday down the road.