Fund Focus: Is Value Investor Tom Forester the Canary in the Coal Mine?

Fund Focus on the Forester Value Fund
Fund Focus on the Forester Value Fund

It will never be easy to pick the right mutual fund, but it was just about impossible in 2008, the market's worst year in living memory. That was the year the Standard & Poor's 500 Index fell 37%, and you no doubt lost a chunk of retirement savings that you haven't recovered yet.

Well, there was one long-only equity mutual fund that didn't lose money in 2008. It was very small, almost completely unknown, and made a barely noticeable profit. The Forester Value Fund (FVALX), named after its founder and portfolio manager, Tom Forester, finished that cataclysmic year with a relatively handsome return of 0.4% -- yes, less than half a percentage point -- on what was then just $50.2 million in assets.

The fund has grown to $102 million in assets since then, but it's not shooting out the lights. It delivered a total return of 18.1% in 2009, underperforming the S&P 500 by 8.37 percentage points. Then it grew 2.3% from Jan. 1 to March 24, which was 3% worse than the S&P.

"On an absolute basis, we are lagging a little bit," admits Forester.

Good Stocks in 2008 Made Lower Gains in 2009

Forester, 51, is a conservative, large-cap value investor who gravitates toward stability. Some of the best-performing stocks in his portfolio didn't get beaten up badly during the crisis. They are large, stable companies like McDonalds (MCD), which is up 15% over the past year, and Johnson & Johnson (JNJ), which is up 38%.

They also fit his rubric for stocks that are trading at historically low price-to-earnings multiples. "You get the best performance out of low PE stocks," says Forester, who was working for famed value investor David Dreman until he launched his own fund in 1999. "I have used price-to-book to value companies, but their book has changed. At least I know what their price and earnings are."

The irony is that many of the large, stable companies in his portfolio did not soar with the market recovery over the last 12 months. The reason is that they did not get beaten down badly enough to have a trough to leap out of. So they almost became a liability, helping to weigh down the performance of his fund. Another reason is that only about 75% of the fund is actually invested in stocks because, he says, many large-cap value stocks just look too expensive to buy. Over the past 12 months, Forester has performed worse than 27% of other large-cap value funds tracked by Morningstar, a fund rating firm in Chicago.

"The markets are trading at about 20 times earnings. Historically, the average is about 14. So things are looking pretty rich right now," he says.

Forester Won't Join in the "Dash to the Trash"

The large-cap value equity funds that are beating Forester got their lift from distressed stocks that had further to climb during the past 12 months, such as large banks with exposure to home loans and mortgage-backed securities. "In 2009, it was kind of a dash to trash," he says. "It's a Pavlovian effect. People didn't know where the bottom was going to be, but once we hit the bottom, people rushed in because that's always what happens."

Sure, bottom-fishing at the right time last year could have given Forester's performance a boost this year. But he has decided to underweight banks in his portfolio because he's not sure they are out of the woods yet. He cites federal government statistics that show an overhang of millions of home foreclosures this year, and a softening of home prices last November and December. He predicts that banks will ultimately be forced to take more write-offs.

"Right now, people are saying, 'It's all done, don't worry about it, they're minting money right now, banks are the place to be.' And I just don't agree with that," says Forester.

Is Another Correction Around the Corner?

You'd think tons of investors would have discovered the fund by now and thrown their hard-earned cash at Forester and his two-person research staff in Chicago. But they haven't. As the old adage goes, "Mutual funds are not bought, they are sold," and Forester never got around to hiring anyone to market his fund until this February. Another reason could be that his fund requires a minimum deposit of $2,500, more than twice as high as the average street-level fund. Since the fund passed the $100 million mark at the end of last year, he says, a registered independent advisor and a couple of insurance companies have started talking to him about the possibility of managing their clients' money.

Financial analysts are also talking to Forester because they have learned to use him as the proverbial canary in the coal mine. The last time he became this defensive was in 2007, when the financial crisis was mounting, says Ryan Leggio, an analyst at Morningstar, which rates the Forester Value Fund at five stars on the firm's five-star scale.

Of course, Forester is the first to deny that he is waving a red flag. "I don't expect things to fall off a cliff again like in '07. But I do expect things to trend down," he says.