Lessons From Morningstar's 2011 Fund Managers Of The Year

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By Carla Fried :

The fund industry's version of the Oscars were just handed out for 2011 by fund research firm Morningstar. And the winners are….

  • Domestic Equity -- the team that manages three separate Artisan funds: Artisan Mid Cap Value, Artisan Value and Artisan Small Cap Value
  • International Equity -- Tweedy, Browne Global Value
  • Fixed Income -- Fidelity New Markets Income

If you're thinking handing out awards based on one-year performance is the height of irresponsibility, well, Morningstar wouldn't disagree. While this year's winners indeed had a fine showing in 2011, Morningstar explicitly looks for funds where last year's strong performance is emblematic of a much longer history of doing right by shareholders. That's the good news. The bad news -- that pesky disclaimer about past performance not being a predictor of future performance.

Smart Doesn't Mean Infallible

The roster of past Morningstar winners is strewn with really smart managers with stellar long-term bona-fides that nonetheless manage to throw in some stink bombs after being anointed. Some low lights: There's Bill Gross (Fixed Income manager of the year for Pimco Total Return in 2000 and 2007, and fund manager of the decade through 2010) who had a god-awful 2011 after bailing on Treasuries. Bruce Berkowitz, manager of the Fairholme Fund, was anointed Domestic Equity fund manager of the year in 2009 and joined Gross as a fund manager of the decade for the first decade of the 21st century. But in 2011 Fairholme rode some big financial sector bets a long way down, losing 32 percent for the year, compared to the 2 percent gain for the S&P 500. That was bad enough to rank in the bottom 1 percent of similar funds.

In 2006, Chris Davis and Ken Feinberg at Selected American rode their growth-at-a-reasonable price approach to the top equity spot, but in four of the five subsequent years the fund has failed to crack into the top 25 percent of similar large-cap funds. More recently, 2010 International Fund manager of the year, Brent Lynn who runs Janus Overseas, subjected shareholders to a 32 percent loss in 2011, ranking in the bottom two percent of similar funds. By comparison, this year's international winner -- Tweedy, Browne Global Value -- managed to lose just 4 percent in 2011. (Yes, you read that right. Morningstar's 2011 International fund of the year actually had a negative return. That's what happens in a year when emerging markets take a serious breather and the EU spends most of the year determined to screw things up more.)

Now this is where you're probably thinking the takeaway from all this is to avoid these sort of beauty contest rankings. But that's not really it. These managers didn't suddenly become dumb once they got the award. Rather, the fact that so many smart guys can fall flat on their face from time to time is all the evidence needed to make the case that persistent and consistent outperformance is ridiculously hard. That's an argument for never putting a huge chunk of money with any one manager, no matter how smart he seems to be. Diversification among funds makes a ton of sense. Patience is also a hallmark of successful investing. You don't give anyone an eternal free ride, but when a Bill Gross throws in one bad year - a really, really bad year - after more than a decade of outperformance, doesn't he deserve a slightly longer leash?

All that said, this all seems to be yet another argument for index funds. Though they will never rank as funds of the year, it's really hard to not love the consistency of index funds, at least as the core of an investment portfolio. They will never rank in the top 10 percent of funds within a given investment category. Nor will they ever break your heart and wallet with a showing in the bottom 10 percent either.

Takeaways for Investors

According to Standard and Poor's, the odds are that an index fund or ETF will outperform an active manager who focuses on U.S. stocks. According to the SPIVA scorecard , over the past five years (through mid 2011-the latest data available) only 42 percent of all actively managed U.S. equity funds managed to beat their bogeys. If you own multiple active funds, the simple math dictates that your odds start to quickly get even lower.

To create an efficient (lowest risk for a given level of expected return) index fund portfolio, it is important to blend together a few different market segments. The other key is keeping expenses low.

A simple stock portfolio that works well for most people:

  • 60% [[VTI]] (Vanguard Total US Stock Market ETF)
  • 30% [[VEU]] (Vanguard FTSE All-World Ex-US ETF)
  • 10% [[ VNQ]] (Vanguard REIT ETF)

On the fixed income side, [[BND]] (Vanguard Total Bond ETF) provides a reasonable and complete solution. Those worried about inflation should consider adding additional exposure to [[TIP]] (iShares Barclays TIPS Bond ETF). Determining the right balance between stocks and bonds is a whole different discussion.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

See also Washington Post Has Good Dividend Growth Potential on

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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