This week, we scan through the year-to-date performance leaders among diversified stock funds to find the best opportunities for long-term growth. Most of the funds on the YTD leader board are small-cap stock funds, which offer higher return potential over the long run in exchange for greater risk. Which ones offer the best risk-adjusted return potential? Let's find out.
We began our screening process by setting the fund group to all domestic stock funds with no-loads and minimum initial purchase amounts of $10,000 or less. To hone in on the hottest funds, we asked for YTD performance greater than 20%. That screen yielded 37 results.
To reduce the number of results, we asked for only funds with a 4-star or 5-star category and overall Morningstar star ratings. Morningstar's category rating is based on 3-year risk-adjusted performance and measures how well a fund has balanced risk and return relative to other funds in its category. Morningstar's overall rating is based on risk-adjusted returns for different time periods (3-year, 5-year, 10-year, and overall), and shows how a fund has balanced risk and return in relation to all U.S. stock funds.
That limited the screen results to a dozen finalists. At that point, we looked closer at the twelve remaining funds, judging them based on both quantitative and qualitative factors. From that analysis emerged two funds we believe offer investors the best prospects of continuing to deliver superior risk-adjusted returns. The two funds are Boston Partners Small-Cap Value II (BPSCX) up 39.1% and CGM Focus (CGMFX) up 38.7% on a YTD basis through 7-23-01. Both funds are profiled below.
Boston Partners Small-Cap Value II (BPSCX)
Retail fund investors may not have heard of Boston Partners, but they are widely recognized among institutional investors, having developed a reputation as a firm rooted in fundamental research and following a disciplined value-oriented investment philosophy and process. Assets under management exceed $11 billion, across separate accounts and mutual funds.
BPSCX is managed by David Dabora, an 11-year veteran. He's one of 34 investment professionals who had worked together for years at Boston Company Asset Management and then left to found Boston Partners in 1995.
Boston Partners Small Cap Value Fund II is comprised of stocks with market capitalizations below $1 billion (65% of assets are in securities valued at $500 million or less) and adheres to the firm's investment philosophy emphasizing value, focused internal research, and risk aversion. This philosophy is executed at the individual stock selection level by concentrating on undervalued securities of companies that have sound business fundamentals and positive business momentum.
Using this strategy, Dabora has delivered superior risk-adjusted results. The fund is up 39% on a YTD basis and is up 62% during the past 12 months, through 7-23-01. This ranks the fund in the top 1% of the small-cap value category, according to Morningstar. It's also an incredible achievement when you consider that stock averages experienced significant downside volatility during this period. For comparative purposes, the S&P 500 index is off 9.2% on a YTD basis and down 18.6% over the past 1-year period.
Morningstar gives the fund its highest 5-star category rating as well as its highest 5-star overall rating. Relative to peers or all domestic stock funds, Morningstar scores fund return as high, with low risk in relation to its small-cap value peers and below average risk relative to all domestic stock funds.
At 1.77%, the fund's expense ratio is a little more than normal, but the fund's higher relative performance more than compensates for the slight expense disadvantage and the fund is offered on a no-load, no transaction fee (NTF) basis through leading networks such as Schwab, E-Trade, and TD Waterhouse.
Yes, there are lots of things to like about Boston Partners and their disciplined small-cap value fund. When I was a corporate plan sponsor a few years ago, we hired Boston Partners to manage a portion of our pension fund assets. I liked them at that time, and still think highly of them. For more information, you can go to www.bostonpartnersfunds.com.
CGM Focus (CGMFX)
This fund barely falls under the category of diversified since it holds a concentrated portfolio of just 17 stocks (compared to 133 for example for the Boston Partners Small-Cap Value Fund), but it swings for the fences. When the fund is hot, it belts home runs, but when it's not, it strikes out. Fortunately for shareholders, this fund is managed by the savvy veteran Ken Heebner, who's well known for his high risk, high return investment style.
Few managers accept as much risk as does Heebner, but then again, few managers can keep pace with Heebner when he's hot. His CGM Capital Development Fund was one of the best fund performers of the 1980s, prompting Heebner to close the fund years ago. CGM Focus is the newer, racier version (as Morningstar puts it).
Think of this fund as representing Heebner's best ideas or what they call in the industry his highest conviction stocks. Heebner takes the approach that at any given time, there are only so many stocks out there with superior risk-reward profiles. These 20 or so stocks are only ones Heebner wants to own - the ones believed to have dramatic upside potential.
Using this high-risk approach, Heebner's has produced incredible returns in an otherwise volatile stock market over the past year. CGM Focus is up 38.7% on a YTD basis, and has a 1-year return of 113.1% through 7-23-01. Compare the 113% positive gain to Janus Twenty's 49% 1-year loss, and you get a sense of how hot Heebner blows away the competition when he's on. Fortunately, Heebner's right more often than he's wrong, but you need a strong stomach.
Morningstar scores CGM Focus as having high risk relative to its small-cap blend peers, and above-average risk in relation to all domestic stock funds. Relative to both category and all domestic stock funds, CGM Focus has produced high relative returns. This high beta, high alpha fund lends itself to the old adage, "Higher returns are normally associated with higher risk."
At 1.20%, the fund's expense ratio is a little below average and a slight help to relative performance, though I don't think that Heebner's needs it. This fund is going to succeed or fail based on Heebner's stock picking prowess.
Aggressive mutual investors with high tolerance for share price volatility have a unique opportunity here. You better also have a long-term horizon of over 5 years (10 years, better) to smooth out the bumps in the road. The 113% return Heebner has racked up over the past year is proof that he's still a great stock picker, but don't say I didn't warn you about the fund's high risk. For more information, go to www.cgmfunds.com.
Summary
Funds get hot for different reasons. The fund's investment style can be in favor with investors, or the portfolio manager may hold one or more righteous rockets. The key is trying to identify the funds that produced their superior results through skill and not luck, and which have the potential to repeat their performance.
This week, we give you two small-cap funds that have banged home runs so far this year and over the past 12 months and which have excellent 'risk-adjusted' performance relative to peers. Boston Partners is a top-notch institutional money manager capable of beating the competition over the long term and those of you who are familiar with Ken Heebner (CGM Focus) know that he gets the job done in his own style for shareholders over the long haul.
Mutual investors who already have a core investment position in stocks or stock funds may want to consider one or both of these funds for the aggressive small-cap portion of your portfolio.
Fund Quotes and Charts
Fund quotes and charts are available at www.hotquotes.com.
