Janus Rebuilt

The Janus mutual fund family has finally worked itself out of purgatory. For the first time since the technology bubble popped early this decade and Janus was named in the rapid-trading scandals, investors have stopped pulling more money from its funds than they have been putting into them. And there's good reason: Janus's funds are on a roll. Over the past one and three years, three-fourths of Janus's funds rank in the top 30% of their categories.

But Janus's new leadership remains unrepentant about the fund firm's maverick approach to managing money -- a style that in the first three years of this decade resulted in excruciating losses for many clients. So why should investors trust Janus again, no matter how well its funds have performed in recent years? Because although Janus's stock-picking philosophy hasn't changed dramatically, the company itself has.

The Janus way originated with Tom Bailey, who in 1969 started an investment firm that would be far away from Wall Street, not just in distance but in disposition. The Denver firm's analysts would conduct original research, looking for fast-growing companies that hadn't yet been discovered by the Street crowd. Bailey drove home the philosophy to recruits by giving them a video, featuring himself on horseback, titled This Ain't No Wall Street Joint.

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With Bailey setting the tone and such franchise managers as Jim Craig and Tom Marsico picking the stocks, Janus built a reputation in the 1980s and early 1990s as a top-notch growth-stock shop. In the late '90s the firm hit marquee status. The flagship Janus fund rose 39% and 47% in 1998 and 1999, respectively. Janus Twenty, a more concentrated fund, rose 73% and 65% in the same two years. By 2000, no fund family was raking in more assets -- at one point, Janus was collecting $1 billion a day. Firmwide assets peaked in 2000 at $330 billion (they're about half that today).

But Janus had turned mainly into a two-trick pony. Its funds held enormous positions in technology and telecommunications stocks, such as America Online, Cisco Systems and Microsoft. And when the tech bubble burst in 2000, Janus funds had a tough time extricating themselves from positions in some of those companies because they held so many shares. The funds cratered like Wile E. Coyote diving onto a canyon floor. During the 2000-02 bear market, Janus fund sank 64% and Janus Twenty plunged 69%. Others suffered even more. Enterprise plummeted 78%, and Global Technology surrendered 84%.

It didn't seem as if things could get much worse. But in 2003, after the bear market had ended and Janus was starting to crawl out of the crater, a boulder flattened it. Regulators nailed the firm for letting some major clients profit from flipping money quickly in and out of funds, a technique that could eat into the profits of the funds' other investors. In 2004, Janus paid $226 million to settle charges that it violated state and federal securities laws.

You can't get anyone at Janus to cop to gluttony as the cause of its bubble trouble. All Janus officials will confess to is being unable to add analysts fast enough to cope with the "influx of capital," causing "the model to break down." They point out that they did close eight funds to new investors during the gold rush, although they concede they should have closed more and acted more quickly. But although their explanation is weak, their atonement has been strong.

The road back

The six-year-long recovery started with admitting that Janus had too few analysts following too few stocks, says Jonathan Coleman, co-chief investment officer and manager of Janus Enterprise fund. In 1999, Janus had 19 stock analysts following some 500 companies. Analysts, on average, had fewer than two years of experience, a byproduct of a philosophy that called for hiring them right out of college and inculcating them in the Janus way. Moreover, young, inexperienced analysts quickly won promotions. "We had a lot of folks running funds who shouldn't have," says Gary Black, who joined Janus from Goldman Sachs in 2004 as chief investment officer and became chief executive last year.

Janus needed a deeper bench -- and fast. So it started hiring analysts with experience. Today, the average analyst has more than five years of experience with Janus, and more than ten years of industry experience. Janus analysts now follow 1,250 companies, including more than 400 foreign firms.

Savvy analysis goes only so far if fund managers pile into the same stocks, as happened in the late 1990s. To guard against that and a host of other sins, Black hired Dan Scherman to be the director of risk. Scherman says his job boils down to making sure managers "don't bet the same way." That means, he says, that he tries to ensure funds don't hold too much of one type of stock or of the same single stock. "Once we're full, we're full," Scherman says. "It forces managers and analysts to find other stocks."

Unnecessary risk is beaten out of portfolios seven ways to Sunday. Scherman makes certain that managers limit exposure to emerging-markets securities and foreign currencies, for example. He also checks to see that managers rely on recommendations by Janus analysts, rather than those from outside research shops, as the basis for a high proportion of their selections.

Janus has also changed the way it rewards managers. Each manager's pay is no longer based on the size of his or her fund. Five-year performance, not just one- and three-year results, is used to figure bonuses. Fourteen Janus funds, accounting for one-third of assets managed, now base management fees on performance, a rarity in the industry (only 211 out of 7,000 other funds feature performance-based fees, according to Strategic Insight). Janus managers also eat their own cooking. Most have more than $1 million apiece invested in the funds they direct.

Finally, Black pledges that funds will close before they become unwieldy. To buttress his promise, he points to Janus Twenty, which has remained closed even as its results have improved and assets have shriveled by 75% from their peak. Says Black: "It would be easy for us to open Janus Twenty. It's had lights-out performance in the past five years, and it's still closed."

You don't need a Harvard MBA to see that Janus's culture has undergone a sea change. But Black, who has an MBA from Harvard, adamantly denies it. He and others at Janus seem touchy at the suggestion because they don't want anyone to think that Janus's basic investment philosophy has been diluted. Jim Goff, director of research, sees the changes this way: "I think we've done a good job of building these disciplines around our strong core without screwing up who we were."

And that core, says Black, "is not that we're a growth shop, but that we're a high-conviction investment shop." That goes back to the belief of founder Bailey, who retired in 2002, that investment success rests on original research and concentration -- that is, holding relatively few stocks. On average, Janus stock funds hold 80 companies, compared with 167 stocks for the average stock fund, says Morningstar. You also won't find Janus funds timidly mimicking indexes. "We're still mavericks, but now we're disciplined mavericks," says Goff.

And despite what looks like a paddock built around them, fund managers still have plenty of room to roam. For example, most of the managers of Janus's nominally domestic stock funds are free to buy, without limit, foreign securities -- a practice rarely found at other shops. Says Janus Contrarian manager David Decker: "I'd no sooner invest just in the U.S. than I would just in the state of Colorado."

Wiggle room

The degree of latitude among Janus managers moves along a sliding scale, with Decker at one extreme. Notwithstanding Janus's concerns about risk, Decker recently had 16% of Contrarian's assets in Indian stocks (and 37% in foreign stocks altogether). He'll invest anywhere in the world if he finds an underappreciated, misunderstood or panic-damaged stock. Example: Plum Creek Timber, a lumber company that he says has been unfairly hammered because of the housing slump. Decker says Plum Creek's strong balance sheet has allowed it to reduce timber cutting during a period of depressed prices and to sit on its appreciating assets. "I bought a great company at a fabulous discount price because of fear," he says.

Decker's eclectic style has paid off in recent years. Contrarian scored an annualized 18% over the past five years to May 1, beating Standard & Poor's 500-stock index by an average of ten percentage points per year. But the fund has also been about one-third more volatile than the index.

On the more sedate side of the conformity scale is Jonathan Coleman, who runs Janus Enterprise. "I like very traditional business models," he says. "I like a high degree of certainty of revenue." One of Coleman's favorites is Lamar Advertising, a billboard company. "Not very exciting," Coleman admits. Billboards may be old media, but Lamar has the ingredients Janus growth managers love: strong returns on capital, high barriers to entry and special circumstances that most other investors fail to recognize -- a finite supply of locations and a captive audience of commuters with ever-longer drives to work. Enterprise, which invests mostly in midsize companies, gained 13% annualized over the past five years, beating the S&P Midcap 400 index by a bit more than one percentage point a year, on average.

Many Janus executives and managers, Coleman included, resent the two mythological metaphors frequently applied to the firm. One is Janus's namesake, the two-faced Roman god. It's been done to death. The other is Icarus, the boy who flew too close to the sun. His wings of feathers and wax melted, and he plummeted into the sea as quickly as many a dot-com stock plunged from triple digits to pennies.

Coleman prefers this metaphor: "Your reputation arrives on a donkey and leaves on an eagle. We let our reputation leave on that eagle, but we got right back on that donkey."

Another Janus opportunity: Buy the stock, not the funds?

Janus recently bought $200 million worth of shares in a company that fits all the criteria its fund managers love. The company has a strong and growing return on capital, most Wall Street analysts don't like it, and bad press has depressed the stock price unfairly. The stock is Janus Capital Group (symbol JNS), and the purchase was part of a planned buyback. At $26 in mid May, Janus Capital trades at half its record price, reached in 2000. But the stock isn't cheap, selling for 22 times the average of analysts' earnings estimates for 2008.

Still, you can make a case for buying shares of the fund company. Stocks of money managers prosper when assets increase because that means higher management fees. The trend for Janus funds is good: The amount by which money going out exceeded money coming into Janus totaled $29 billion in 2004. The figure shrank to $16 billion in 2005 and $10 billion last year. Janus chief executive Gary Black expects inflow to exceed outflow slightly this year.

Much of the improvement stems from a relatively new strategy of selling Janus funds through brokers, as well as directly to investors. And Janus Capital is more than just the Janus funds. Its Intech investment business, which manages money for institutions, has been growing strongly for years and now accounts for 38% of Janus Capital's assets.

One potentially bullish development would be the long-anticipated revival of growth stocks, the segment of the market in which Janus specializes. "We've had this huge headwind," says Black. Once the wind changes directions -- and it inevitably will -- look for Janus's funds to perform better and for the company's shares to follow.

Top picks: The best of Janus's stock funds

All five funds listed below have produced good to great results over the past few years, and all sport moderately low expense ratios (they range from 0.91% to 0.99% annually). But Janus's growth-oriented funds performed pitifully during the 2000Ð02 bear market, and some have aggressive positions (think big holdings in Indian companies) that may make them vulnerable the next time stocks sag for an extended period.

Data to May 1. N/A not applicable. Note: Bear-market returns are cumulative for the period March 24, 2000, through October 9, 2002. Source: ©Morningstar Inc.