Value Added


3 Former Star Funds to Avoid

Steven Goldberg

They were supposed to be among the best value funds around, but were savaged in the 2007-09 bear market. I'm still leery of them.



October 9 passed without most people taking any special notice. But mutual funds were watching. October 9, 2007, marked the start of the worst bear market since the Great Depression. Every day that passes now makes the five-year returns of mutual funds look just a bit better.

SEE ALSO: Our Guide to Mutual Funds

But I'll never forget that calamitous bear market, and I hope I never forget the lessons I learned. Most important: The idea that stock funds run by top-notch value-oriented managers would protect me in a severe downturn turned out to be wishful thinking. More than a few such funds produced horrendous bear-market returns. They turned out to be far riskier than I expected.

I'm not talking about funds that blew up, such as Bridgeway Aggressive Investors (symbol BRAGX), CGM Focus (CGMFX) and Legg Mason Value (LMVTX). Those three, which I once favored, did so badly that virtually no one recommends them anymore. They billed themselves as bold funds, and their boldness ultimately did them in. The result was devastating losses for their shareholders.

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No, I'm referring to solid, prudent, well-managed value funds -- the ones that many colleagues and I have often suggested should be the core of your stock portfolio. Specifically, I'm talking about Dodge & Cox Stock (DODGX), Longleaf Partners (LLPFX) and Selected American Shares (SLASX). They all got creamed during the bear market, each losing more than the major stock indices, which themselves took a terrible beating.

All three funds had superb long-term records and didn't appear to take huge risks. All were known for researching stocks intensively. But each ended up holding companies that imploded in the bear market.

I don't think these are awful funds. But I don't want to entrust my clients' or my own hard-earned money to them while so much uncertainty continues to plague the world's economies. With the Federal Reserve printing money to juice the U.S. economy and the euro zone still facing the risk of collapse, I don't want to invest with managers who stretch for the cheapest, most beaten-up stocks. I think a more conservative approach is warranted.

Dodge & Cox is known for hiring analysts and keeping them throughout their careers. The firm was renowned for its thorough research. How then did it end up with big stakes in the shares of Fannie Mae, General Motors and Wachovia? GM required a federal bailout, Wachovia had to merge with Wells Fargo, and mortgage giant Fannie Mae is still a ward of Uncle Sam. General Motors and Fannie Mae shareholders were wiped out; Wachovia shareholders received a sliver of Wells Fargo stock.

Of the three funds I'm highlighting, Dodge & Cox Stock has the best long-term record. (The fund remains in the Kiplinger 25.) But I believe the mistakes its managers made in 2008 reveal deep flaws in the fund's stock picking, as do more recent problems with stocks such as Hewlett-Packard. As a result of the fund's miserable bear-market performance, it has lost an annualized 1.8% over the past five years. That's an average of 2.4 percentage points per year worse than Standard & Poor's 500-stock index. (Except for the bear-market figures, all returns in this article are through October 28.)

Dodge & Cox has been 20% more volatile than the S&P 500. That volatility was on full display during the bear market from October 9, 2007, through March 9, 2009. The S&P tumbled 55.3%, but Dodge & Cox lost 62.4%.

Longleaf Partners makes Dodge & Cox Stock look placid. GM was a top Longleaf holding, too. So was Chesapeake Energy, a stock that has not regained its mojo since it cratered in 2008. Longleaf, which has been nearly 20% more volatile than the S&P, crumpled by 64.8% in the bear market. Consequently, over the past five years, Longleaf has lost an annualized 1.6%.

Selected American Shares was founded by a grandfather of co-manager Christopher Davis. Shelby Cullom Davis believed that financial stocks were growth stocks in disguise. Consequently, he theorized, financial stocks shouldn't be cheaper than other stocks on important measures of value. As a result, the Davis funds have always owned more than their share of financial stocks. Well, it turns out that many financials deserve to sport lower ratios of price to earnings and price to book value (assets minus liabilities) than other kinds of companies. Put simply, many financial companies are far less transparent than other firms, and they have a tendency to blow up every so often.

Selected held shares of such errant companies as American International Group and Merrill Lynch. AIG required a massive federal bailout; Bank of America absorbed Merrill. Selected lost 59.1% in the bear market.

After beating the market in 2009, it has trailed the S&P for three straight years, including this year. Give the fund credit for being slightly less volatile than the S&P.

I'm not the only one who paid a costly price to learn lessons about investing during the bear market. These fund managers did, too. The question is, what did they learn?

Selected American's managers seem to have become more careful since the catastrophe, but I hear nothing from the other two funds that encourages me. Of course, for all three, the proof of the pudding is what they invest in and the returns they produce in coming years.

Bottom line: I'm not buying any of these funds, and I think you should be wary, too. Ditto for many of the other stock funds that cost their clients big-time in the bear market.

Steven T. Goldberg is an investment adviser in the Washington, D.C. area.


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