3 Investors Who Easily Beat Benchmarks

BOSTON (TheStreet) -- In the battle of man versus machine, mutual fund managers must prove their mettle against computer-driven index and exchange traded funds, which have grown in popularity as cheap alternatives.

Assets in ETFs, for example, grew to $1.1 trillion on March 31, more than double the $432 billion at the end of 2006.

Todd Rosenbluth, a Standard & Poor's mutual fund industry analyst, said investors who previously would have put money in large-cap mutual funds are opting for ETFs or S&P 500 index funds. Many continue to use small- and mid-cap stock mutual funds for their hot performance.

And, yet, actively managed funds have outperformed the S&P 500 Index over time, lending credence to the argument that the more nimble of these funds can mitigate downside risk and can take advantage of trends that the follow-the-crowd bet of an index fund can't.

There are 2,504 U.S. stock open-end mutual funds that have a three-year performance record, as of April 28, Morningstar said. Of those, 1,659, or 66%, had a higher return than the S&P 500 Index, though some use other indices as benchmarks.

The fund industry is well aware of investors' drift to passive funds. "Over time, the traditional mutual fund industry is going to have to demonstrate (outperformance) and earn their assets by doing better than ETFs," said Lawrence Rakers, manager of the Fidelity Dividend Growth Fund(FDGFX). "And that's what we do every day."

ETFs don't select stocks themselves because they're based on indices, and "they can actually misprice securities" since investor sentiment, rather than fundamentals, can sway an exchange traded fund's value.

Actively managed mutual funds should be the first and, in some cases, only choice for most individual investors' portfolios, said James Lowell, the longtime editor of the independent Fidelity Investor newsletter and chief investment officer of the $2.4 billion Adviser Investments money-management firm.

That's because "it's not that hard to find good managers in the actively managed space who, at very little cost, are riding herd on your investment portfolio day-in and day-out and through the tumultuous times" when many people, left to their own devices, pull their money out, he said.

ETFs and index funds, however, require constant vigilance. "They are no better or worse than mutual funds, or stocks and bonds, but they increasingly require more legwork to keep up with," said Lowell. "And, ultimately, ETFs are designed to meet a benchmark that fund managers spend their whole careers working to outperform."

The eternal issue, though, is how to pick a fund manager who's consistently head-and-shoulders above the crowd.

"This is a question we all struggle with," said Jeff Tjornehoj, head of Lipper's research in the Americas. "What I think it comes down to is that it's really more art than science. Some people seem to have an intuition about the market that their peers do not."

Here are three mutual fund managers who have outperformed their benchmarks and peers over the past three years, along with some of their top picks: