By Eric J. Savitz
he overall winner of our mutual-fund manager ratings this year is Robert Sanborn, whose Oakmark Fund has returned an average 29.2% a year since it was founded in 1991. That's better than double the 14.3% annual gain notched by the average stock fund. As Oakmark's outstanding results suggest, Sanborn is different from most other mutual-fund managers. Unafraid to bet heavily on companies he believes in, Sanborn has more than half of his $5.6 billion portfolio in just 10 stocks. Another sign of confidence: He holds on to his stocks for an average of four years, nearly quadruple the time that other fund managers do.
Never a slave to financial fashion, Sanborn shuns technology shares and finds little value in Wall Street research. He's what we at Barron's feel every portfolio manager should be -- an independent thinker and a great stockpicker.
Sanborn's place atop the mutual-fund heap should come as no shock. He placed third in last year's ranking, and he exemplifies the kind of manager our ranking criteria were set up to find: men and women with a demonstrated record of outperforming their peers, year after year after year -- without taking undue risk. Our latest rankings, carried out with the invaluable help of Value Line, reflect fund performance through June 30. Behind Sanborn, the top finishers include James Margard, who runs Rainier Small/Midcap Equity, Gerald Zukowski of Putnam Capital Appreciation, Neal Miller from Fidelity New Millennium, and Fariba Talebi, who pilots Schroder U.S. Smaller Companies.
We did not include sector funds, country funds, index funds and bond funds. There's nothing inherently wrong with any of these fund types, but the whole point of our ratings system is to reward outstanding stockpickers who look at a broad selection of stocks. We also eliminated any fund whose manager had not been in place for at least three years, and we knocked out team-managed funds.
When you look at our ratings, you will see a positive number accorded to managers who do better than average, a negative score to underachievers. You can think of our ratings as a rough measure of the value added by each mutual-fund manager. The higher the rating, the more effective the manager has been compared with people running similar funds. To account for risk, we subtracted points for any fund that had overly volatile performance, and we added points for those whose returns were unusually stable. Importantly, each fund was compared to others with similar investment goals for the full term of the current manager. The longer the current manager has been in place, the more data are used to rate the funds.
Taking all of our criteria together, a manager who had average performance with average volatility would get a score of zero. On page 36, you'll find an overall ranking of the 100 best fund managers. In addition, on pages 38 and 39 are tables showing the top five managers for each of 10 different types of mutual funds. For readers who like to look at car wrecks, there's a list of the 10 worst-rated managers under our system on page 40.
Our approach isn't without controversy. Consider Wasatch Mid-Cap, which ranks among the 10 lowest-rated funds. As Value Line's Steven Savage notes, the fund's performance is not all that bad. But it has underperformed its peers since its inception, and it has had much higher volatility than the overall market. That kind of behavior generates low ratings.
The Franklin funds had a particularly strong showing in this year's rankings, with three of its Templeton funds, one of its Franklin funds and three of its Mutual Series funds all finishing in the top 100. Fidelity has six funds in that elite group; T. Rowe Price, five; and Morgan Stanley, four. No other fund company had more than two funds in the top 100.
Michael Price had the distinction of being the only manager to run three funds ranked in the top 100, with Mutual Beacon, Mutual Qualified and Mutual Discovery. A number of other managers showed up twice, though, including Chuck Royce, of Royce Premier and Royce Total Return; Hakan Castegren, of Harbor International and Ivy International; Helen Young Hayes, who runs Janus Worldwide and IDEX Global Portfolio; James Margard, of Rainier Core Equity and Rainier Small/Midcap; Jean-Marie Eveillard, of SoGen Overseas and SoGen International; Mark Holowesko, of Templeton Foreign and Templeton Growth; Richard Weiss, from Strong Common Stock and Strong Opportunity, and Roger Honour, of Montgomery Growth and Montgomery Asset Allocation.
Of last year's top five finishers, Sanborn is the only repeat performer. In part, this reflects the strong showing on last year's list of small-cap growth managers, many of whom have been mowed down by the slump in small-caps during the past 12 months. Mary Lisanti, who topped last year's rankings as the manager of Bankers Trust Investment Small Cap, has since changed jobs, moving to Strong Small Cap, which has struggled of late, with a small loss for the year to date. The small-cap growth orientation at two other of last year's top performers, PBHG Emerging Growth and Perkins Opportunity, has likewise caused those funds to lag badly. PBHG Emerging Growth this time ranked 142nd of the roughly 800 funds that qualified for our ratings, while Perkins Opportunity plunged to 359th.
AIM Aggressive Growth is now listed as team-managed, and so fell out of contention. AIM Aggressive has performed poorly in the past year anyway, though not as poorly as others among last year's top five.
Sanborn, who finished first in the growth-fund category, summarizes the Oakmark strategy as "buying pieces of businesses for the long term, not pieces of paper for the short term." It's Warren Buffett value-style investing, taking concentrated positions and sticking with them. The approach starts with trying to buy businesses that sell below their underlying value. Ideally, Sanborn tries to buy companies selling for 60% or less of what he feels they are worth, and he sells when valuations approach 90% of their worth. Sanborn keeps a particularly careful eye on cash flows, and notes that he's "jaundiced against businesses that likely will change significantly over the next five years," which leads him to shun tech stocks.
Sanborn likes managers who care about shareholder value, and he looks for companies offering stock incentives to management. As noted, he also takes big positions. Sanborn has 70% of his fund in just 20 stocks, with the top five alone accounting for nearly 30% of its assets. "I have no interest in being a closet indexer," he explains. "I have no technology stocks, no utility stocks, little in the way of energy stocks, and not much in the way of heavy industry. Those areas together probably account for 30%-40% of the S&P 500."
Meanwhile, Sanborn tries to keep trading to a minimum. In his view, shuffling positions costs shareholders money. Turnover this year is even lower than usual -- less than 20%. Not least, Sanborn tries to think independently. "We don't rely on the Street for research or ideas," he says. "We like to think we know our companies as well as any outsider could."
Oakmark has long had big positions in both financial and consumer stocks, and the current portfolio reflects big weightings in each. Philip Morris /zigman2/quotes/208895754/composite MO -2.50% , a stock Sanborn bought for Oakmark on the first day the fund opened for business, remains the portfolio's largest position, about 8% of assets. Sanborn says his bullish stance won't be affected by the outcome of the proposed tobacco settlement. Either way, he figures, the cost burden will eventually be passed on to smokers. Sanborn figures the stock is worth $70 a share if there's a settlement; $80 a share, but with more risk, if the pact falls through. (It has been trading in the mid-40s.) Despite all their troubles, Sanborn thinks the tobacco companies have a great business-demand for cigarettes is relatively inflexible, the entrance of new competition is unlikely, and the availability of substitute products is essentially nil.
Oakmark's second-biggest holding is Banc One . Shares in the Ohio-based banking giant came Oakmark's way through Banc One's acquisition of First USA, a credit-card processor whose stock Sanborn rode from 2 to more than 50. Selling the position into the acquisition would have created a giant tax liability for Oakmark shareholders, Sanborn concedes, and that contributed to his decision to hold on. Nonetheless, he thinks Banc One is a worthy investment, trading at a discount to its peers. Rounding out the fund's top five are Mellon , Black & Decker and Polaroid .
At the moment, Oakmark has about 15% of its assets in cash, which Sanborn says is an all-time high. "The environment remains very good, but valuations are lofty," he says. "We're having a hard time finding individual companies that meet our criteria."
The survey brought a double dose of good news for James Margard. His Rainier Small/Midcap, finished second in our overall ratings and first in the small-cap category, while his other fund, Rainier Core Equity, which buys large-cap stocks, finished ninth overall and sixth in the growth category. Both funds are part of Seattle-based Rainier Investment Management, and they use similar strategies, trying to buy "growth at a reasonable price." Adherents "GARP" investing look to buy companies whose earnings are expanding at an above-average rate, while their shares are selling at below-average price-to-earnings multiples. And, in fact, the portfolios for both of Margard's funds have average growth rates above the market and average P/Es below the market.
Margard meshes his GARP strategy with a firm emphasis on controlling risk. "We do no market timing, and we take no sector bets, keeping the industry weightings of the fund within 5% of the market," which he defines as the Russell Midcap in the case of Rainier Small/Midcap Equity, the S&P for Core Equity.
Margard also tries to be a good trader. He emphasizes the fact that Rainier's managers all share the research, portfolio management and trading chores. Almost never in his office, Margard instead spends most of his day at Rainier's trading desk. As you might expect, that leads to higher-than-average turnover, as high as 140% a year, Margard estimates. And the firm's research process isn't as intensive as, say, Oakmark's. "We don't try to reinvent the wheel and laboriously crank out P&L statements projected out five years," he says. "And we don't periodically take two-day trips to Cincinnati to ask P&G how Tide is selling. We home in on the raw, hard numbers. Is the stock cheap? What's the earnings growth like? What's the trend in the direction of earnings estimates? We look at cash flow, and at the balance sheet. We're not kicking the tires for three days, but we're not pure quants, either."
Part of Margard's effort to control risks involves diversification -- the fund owns 117 stocks, with no position representing more than 2% of assets. The fund's biggest holding is Cadence Design Systems , which operates in a software niche called electronic design automation, or EDA. The stock illustrates Margard's focus on relative valuations. Cadence, he says, has historically traded at a P/E about a third above the market, but it now trades at a P/E just 5% above the market. The rest of the fund's larger holdings reflect an eclectic mix. The top five are rounded out by Hartford Life, Everest Re /zigman2/quotes/200609425/composite RE -1.76% , Bank United of Texas and Manor Care, followed by Titanium Metals , General Nutrition , ReliaStar , Adobe Systems /zigman2/quotes/200389143/composite ADBE -1.42% and Parametric Technology .
It's not easy to pin down exactly how Gerald Zukowski runs Putnam Capital Appreciation, which finished third overall and second to Oakmark in the growth category. For starters, he's about the only manager at Putnam who has managed to avoid the firm's team-based investment approach. Maybe because he's been around longer, having entered the investment business fresh out of Harvard Business School in 1961. Whatever the reason, Putnam seems to give Zukowski a free hand to fiddle with this fund, and fiddle he does. Chuckles Zukowski: "They had trouble figuring out where I fit in."
Zukowski calls himself an "uncomfortable speculator," which is one reason the fund owns close to 300 stocks. In one breath, he describes himself as a GARP investor, looking for cheap growth stocks. In the next breath, he's sounding like a value fan, singing the praises of buying down-and-out merchandise. Zukowski says his portfolio is in a constant state of flux, with his "farm team" of potential gems regularly being either kicked out for bad performance or beefed up to larger positions. And yet, his turnover has been running about 50%, far less than other aggressive funds.
A shrewd stockpicker? Well, in part. Zukowski also makes some big top-down decisions. For instance, he pays a lot of attention to a company's size. At the moment, he's convinced that small-caps will remain troubled for some time to come. In fact, the small-cap portion of his fund has been reduced to about 28%, down from a peak of 60%. And about a quarter of the fund's small-cap positions represent real-estate investment trusts. "The environment is not that attractive for small-caps for economic reasons," he contends. "Small-caps work better when the Fed is cutting rates."
A look at Putnam Capital Appreciation's 10 largest holdings provides evidence of its current large-cap bias: ranking one through five are Warner-Lambert , Chase Manhattan , Santa Fe International , General Electric /zigman2/quotes/208495069/composite GE -2.41% and Calpine , followed by Rite Aid /zigman2/quotes/201733831/composite RAD +1.74% , Sundstrand , Tupperware /zigman2/quotes/209009040/composite TUP -0.87% , Storage Technology and RMI Titanium . "It's one of the most complicated markets I've ever seen," Zukowski marvels. "Low inflation, low rates, terrific earnings .. it's all sort of nerve-wracking. We're getting some high valuations, and new valuation parameters make managers uncomfortable, which pushes them toward liquidity. But since 1990, holding cash has been a mistake. So people prize the security they get with large-caps. Which means large-caps should continue to do better."
Zukowski says he buys such a large group of stocks to hold down risk. "There are guys here who think I'm crazy," he admits. "But the concept is quite simple. I'm looking for undervalued, overlooked, inefficiently priced companies. We have tremendous diversification for good reason -- I'm buying some really gamy little companies. And yet, we show up quite well on most risk parameters, and we do relatively well in down markets." In 1996, the fund returned 30.1%, beating both the Russell 2000 and the S&P 500, thanks in part to a timely exit from technology stocks last spring. The smart returns have not escaped notice. Now 3 1/2 years old, the fund has more than doubled in size since the end of December, and it now has close to $1.3 billion in assets.