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Nov. 7, 2007, 9:57 a.m. EST

Market turmoil threatens records of top fund managers

Vanguard, American Funds among leaders with eight-year strings in jeopardy

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By Murray Coleman, MarketWatch

SAN FRANCISCO (MarketWatch) -- In the waning months of 2007, more than a dozen money managers are struggling to keep alive the industry's longest streak of beating the market.

For those who wind up losing, it'll mean the end of eight consecutive years of outperforming their respective benchmarks.

Those who, in turn, win will move closer to matching the previous longest streak -- 15 straight years -- set by Bill Miller. Of course, his Legg Mason Value Prime Fund /zigman2/quotes/203623666/realtime LMVTX +0.88% broke that string last year and continues to lag the S&P 500 index /zigman2/quotes/210599714/realtime SPX +0.75% .

/zigman2/quotes/203623666/realtime LMVTX 112.87, +0.98, +0.88%
/zigman2/quotes/210599714/realtime SPX 4,471.37, +33.11, +0.75%
LMVTX

In 2006, the second-longest string also fell.

That came after Manu Daftrary's Quaker Strategic Growth Fund /zigman2/quotes/207960963/realtime QUAGX +0.90% missed the S&P 500's returns by a wide margin. It also ended hopes that this year could be its ninth of surpassing its index.

But some 27 other diversified stock mutual funds made it through year eight of upending their closest benchmarks, according to investment researcher Morningstar Inc. So far this year, nearly 60% of those managers are trailing their respective indexes, however.

The endangered group represents some of America's largest and most popular fund families. Managers of popular funds at Vanguard Group, American Funds and Franklin Resources Inc. /zigman2/quotes/201997162/composite BEN -0.30% are all trailing their best-fit indexes.

/zigman2/quotes/207960963/realtime QUAGX 52.62, +0.47, +0.90%
/zigman2/quotes/210599714/realtime SPX 4,471.37, +33.11, +0.75%
QUAGX

"I can't recall a year in which so many talented managers were experiencing such a tough time," said Christine Benz, director of mutual-fund analysis at Morningstar.

A big part of this year's underperformance relates to turmoil in financial stocks. "Those can be more complicated businesses that take a lot of work from an analyst's point of view," Benz said.

In past years, managers who've been willing to roll up their sleeves and dig into those companies have been rewarded with oversized returns, she added.

"If you look at underperformers this year, it reads like a who's who list of great value managers," Benz said.

Some value-minded investors flirting with ending eight-year streaks are Cambiar Opportunity Fund /zigman2/quotes/209711246/realtime CAMOX +0.79% and Templeton World Fund /zigman2/quotes/208350079/realtime TEMWX +0.91% .

Included in that list is David Herro, Morningstar's International Fund Manager of the Year in 2006.

This year, his Oakmark International Fund /zigman2/quotes/207122714/realtime OAKIX +1.07% and eight-year winner Oakmark International Small Cap Fund /zigman2/quotes/201098659/realtime OAKEX +0.74% are badly off their marks.

"What we're seeing is a momentum-based rally primarily into a few select areas like China and Brazil," Herro said. "I'd compare this to the tech rally at the end of the '90s. People seem to think demand from emerging markets is going to keep going up into perpetuity."

But he warns that in the past year leading players in cyclicals and natural resources have greatly increased their capital-spending budgets. "We're probably looking at a major upsurge in supply in a number of markets," Herro said. "And it's likely to happen when we least expect it."

If global markets slow as expected, he points out that raw-materials producers must deal with a wide assortment of fixed costs. "If pricing drops, they've got to keep producing to cover those expenses," Herro said.

The last time he's gone through this sort of a slump was in 1998. "And that was because we were invested in Asia. This time it's ironic: We're having a bad year partly due to the fact that we're not invested in Asia," Herro said with a laugh.

But many of the eight-year overachievers trailing their bogeys this year are categorized as growth-styled funds. The common thread to be seen here is a tendency to manage more conservatively that most of their peers. Most have a history of lagging their more aggressive rivals when conditions are favorable.

"The market has definitely rotated toward more high-octane growth names," said Nicholas Kaiser, manager of Amana Growth Trust Fund /zigman2/quotes/207209424/realtime AMAGX +0.78% . "So it's not surprising we're looking rather average these days."

Despite being classified as a growth-minded investor, he also uses a price discipline in his fundamental stock-picking process. That means eschewing Google Inc. /zigman2/quotes/205453964/composite GOOG +0.19% and other high-flying equities. "We'll never own a rich stock like Google," Kaiser said.

Still, his fund's performance this year is running neck and neck with the Russell 1000 Growth index. The fund, which invests in a way that conforms to Islamic ideals, has beaten 98% of its large-cap growth rivals over the past five- and 10- year periods, according to Morningstar.

Other eight-year winners in danger of losing their string are American Funds Growth Fund of America /zigman2/quotes/208876675/realtime AGTHX +0.67% and American Funds New Economy Fund /zigman2/quotes/200128272/realtime ANEFX +0.56% .

Also in trouble is a trio of large-cap growth Vanguard funds, including Vanguard Morgan Growth and Vanguard Primecap Fund /zigman2/quotes/204022030/realtime VPMCX +0.80% .

Both of these are trailing by more than 2.5% from their category's benchmarks. And each has fallen into the second-half of their peer groups.

In Primecap's case, top choices through Sept. 30 such as FedEx Corp. /zigman2/quotes/203047719/composite FDX +0.73% , Novartis AG /zigman2/quotes/203243705/composite NVS +0.88% and Medtronic Inc. /zigman2/quotes/206816578/composite MDT +2.36% held back its relative performance. Earlier in the year, other names such as Boston Scientific Inc. /zigman2/quotes/203726728/composite BSX +0.35% and Amgen Inc. /zigman2/quotes/209157011/composite AMGN +0.51% were listed as key contributors.

For Morgan Growth, stocks with top 10 positions entering October that have been dragging on performance were Walt Disney Co. /zigman2/quotes/203410047/composite DIS +1.18% and Altera Corp. /zigman2/quotes/205871240/composite ALTR -0.33% , while Accenture Ltd. /zigman2/quotes/201711136/composite ACN +0.82% and Forest Laboratories Inc. were among other underachievers held in the portfolio earlier in the year.

Both funds continue to have stellar long-term records. In the past 10 years, Primecap has outperformed 95% of its peers, while Morgan Growth is beating some 74% of large-cap growth funds.

And Vanguard Healthcare Fund /zigman2/quotes/209245373/realtime VGHCX +0.48% , which has beaten its index every year since 1998, continues to lead 99% of its rivals despite falling well behind health-care indexes this year.

"The same managers who built those great long-term track records are still in charge today," said Kevin Norris, chief investment officer at Girard Partners Inc. "They're still investing the same way they always have in the past."

The King of Prussia, Pa.-based adviser is using the Healthcare fund and Primecap in portfolios of its high net-worth clients. The firm also tracks Morgan Growth and has it on "our radar screen," says Norris.

"They're all having an off-year, but we're confident these funds are in good hands," he added.

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Murray Coleman is a reporter for MarketWatch in San Francisco

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