Bruce Fund Falls Back to Earth

For most of the '00s, Bruce fund was one of the best mutual funds on the planet. Its ascent was remarkable considering that it had been one of the worst for many years before the turn of the century.

But Bruce, run by the father-and-son team of Robert and Jeff Bruce, has performed poorly in 2007, raising questions of whether the $308-million fund has reverted to its old, feeble ways.

Bruce's results this year -- down 3.6% through December 12 -- are undoubtedly disappointing to clients who had grown accustomed to juicy gains. How good was Bruce before things soured this year?

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From the start of 2000 through the end of 2006, the fund gained 29.7% annualized. That clobbered Standard & Poor's 500-stock index by an average of 29 percentage points per year. And it trampled "moderate-allocation" funds (Morningstar's version of balanced and other funds that typically keep 50% to 70% of assets in stocks and the rest in bonds and cash) by an average of 26 points per year.

And how bad was Bruce before the glory years? Bad enough to have been inducted into the Kiplinger Hall of Shame in 1992. The fund continued its mostly miserable ways right up to Y2K.

In the 1990s, Bruce (symbol BRUFX) returned 5.8% annualized. That compared with a 17.5% annualized return for the S&P 500 and an average annualized gain of 12.5% for moderate-allocation funds.

The secret of Bruce's performance -- both good and bad -- lies in the nature of its holdings and, oddly, in its stability. The fund invests mostly in shares of small-company and microcap stocks (the smallest of the small), as well as in bonds, including U.S. Treasuries and convertible corporate bonds (converts are bonds that can be converted into an issuer's common stock and, thus, share traits of both bonds and stocks). Zero-coupon bonds, whose prices move sharply and inversely with changes in interest rates, account for nearly all of the bonds.

Moreover, the Bruces don't trade frequently. In the fund's 2007 fiscal year, for example, turnover was 15%. That suggests that the managers hold securities for nearly seven years, on average.

Turnover was 10% in the 2005 fiscal year. As a result, Bruce's results almost always depend strongly on the popularity of ultra-small-cap stocks and the direction of interest rates (when they fall, the bond portion of the fund excels).

Lousy microcap performance hurt Bruce fund in 2007, says Morningstar analyst Michael Breen. The Russell Microcap index sank 8% year-to-date through December 12.

Bruce fund does own some large-company stocks, such as Merck, Pfizer and UAL, but they represent a small percentage of the portfolio. Breen says most funds in Morningstar's moderate-allocation category have about 60% of their holdings in blue-chip stocks.

So what does the father-and-son management team plan to do now that smallcaps are out of favor? It's hard to say. Jeffrey Bruce politely declined Kiplinger's request for an interview, saying that his fund doesn't advertise and neither he nor his father is interested in media coverage.

The fund's public filings, including its shareholder reports, do little to illuminate the Bruces' strategy. The most-informative bit in the letter in the June 30 annual report allowed that the fund's cash position -- then at nearly 25% -- was relatively high as the managers searched for "reasonable long-term capital appreciation opportunities."

Investing in Bruce fund requires a lot of faith in its managers and in the revival of the smallcap stocks the fund favors. Breen says he can't recommend the fund because the logic behind what the Bruces buy and sell is unclear: "It's impossible to argue with the fund's success, but only those investors willing to put nearly blind trust in management should consider it."