A Buffett Disciple Hangs Tough

How bad was the U.S. stock market over the past year? The best performers among diversified U.S. stock funds were those that specialize in small, undervalued companies -- and that group still lost an average of 29%. Royce Special Equity (symbol RYSEX), one of the category's stars, lost just half as much.

Charlie Dreifus, manager of Special Equity since its 1998 inception, says his stock-picking approach is an amalgam of the teachings of three legendary financial figures. In a nod to Benjamin Graham, considered the father of security analysis, Dreifus buys stocks only when they're dirt-cheap. Like Warren Buffett, he looks for companies with a sustainable competitive advantage. And following the tenets of Abraham Briloff, his accounting professor at City College of New York, Dreifus brings, as he says, a cynical eye to "trying to gauge the veracity of financial statements."

Special Equity did even better in this decade's first bear market. During the 2000-02 downturn, the fund gained 53%, compared with a loss of 41% for the Russell 2000 index of small-company stocks. Dreifus says his fund has held up better than most during the current bloodbath because his holdings "have two precious commodities: abundant equity and abundant cash."

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This cautious fund often lags when the stock market sizzles, but it has excelled over the long haul. Over the past ten years through December 31, it gained 8% annualized, beating Morningstar's small-value-fund index by an average of two percentage points per year.