For Mutual Funds This Year, Think Big

Larger companies stand a good chance of outperforming in 2010. Here are mutual funds poised to benefit from that strategy.
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NEW YORK (

TheStreet

) -- Investors will remember the past decade as a miserable time. But not all stocks suffered.

While the

Dow Jones Industrial Average's

member companies languished, many small firms performed well. Over the past 10 years, the average small-blend fund -- a mix of growth and value shares -- returned 6% annually, compared with a measly 0.3% for large-blend funds, according to Morningstar.

Blue chips faced hard going partly because they had become overvalued. For five straight years in the late 1990s, large stocks soared and reached outlandish levels. Meanwhile, small stocks trailed and remained at reasonable price-to-earnings ratios. When the

S&P 500

collapsed in 2000, small stocks stayed in the black. Since then, small companies have led most of the time. During 2009, small-blend funds returned 32%, compared with 29% for large blend.

Can large stocks take the lead this year? Perhaps. Many blue chips seem to be reasonably priced. The average large-blend fund has a P/E ratio of 14.9, lower than small blend's 15.4. In addition, large companies are benefiting more from fast-growing emerging markets.

To find promising choices, I screened for large-cap funds that excelled in the rollercoaster markets of 2009. I looked for funds that hold multinationals and other stocks that seem poised to profit from a global economic recovery. As a final check, I limited the group to portfolios that have moderate P/Es compared to their peers.

For investors who prefer growth stocks, my choice is

Alger Spectra

(SPECX) - Get Report

, which returned 57% in 2009, clobbering the S&P 500 by 30 percentage points. During the past five years, the fund returned 10.3% annually, outdoing 99% of its large-growth competitors.

Manager Patrick Kelly favors dominant companies that are gaining market share. He seeks businesses that can grow for at least three years because of management changes or innovative products. Kelly aims to avoid overpaying, seeking stocks that sell at modest prices.

A favorite holding is

Hertz

(HTZ) - Get Report

. While the rental-car business has been hurt by the recession, Hertz has gained market share from troubled competitors. "We expect demand to recover soon, which will lead to a tight rental market and higher pricing," Kelly says.

He also owns

Microsoft

(MSFT) - Get Report

. Kelly says sales of personal computers will grow faster in the next couple years than that expected by Wall Street. Because of the strength of its new operating system, Microsoft will generate growth.

To bet on unloved stocks, consider

Master's Select Value

(MSVFX)

, which returned 44% in 2009. The fund is overseen by Litman/Gregory Advisors, which hires four well-known managers to run the assets.

To ensure that Master's Select Value stays diversified, Litman/Gregory Chief Investment Officer Jeremy DeGroot picks managers with different approaches. The team includes Mason Hawkins, the veteran manager of

Longleaf Partners

(LLPFX) - Get Report

, who seeks solid businesses selling at big discounts. Two other managers, Clyde McGregor of

Oakmark Equity & Income

(OAKBX) - Get Report

and Bill Nygren of

Oakmark Select

(OAKLX) - Get Report

, tend to pick unloved stocks that fit in the blend box. Peter Langerman of

Mutual Shares

(TESIX) - Get Report

favors deep-value stocks, sometimes taking troubled companies.

Each manager picks from eight to 15 of his favorite stocks for the Master's fund. "Our thesis is that a manager's favorite stocks will outperform his diversified flagship fund," DeGroot says.

The managers don't excel every year. During the downturn of 2008, some financial holdings exploded, and Master's Select Value lagged behind its competitors. But the fund came roaring back this year. Holdings that rebounded smartly in the past year include

Chesapeake Energy

(CHK) - Get Report

, a natural-gas producer, and

Dell

(DELL) - Get Report

, which soared when technology stocks revived.

An intriguing choice for dividend investors is

Hennessy Cornerstone Value

(HFCVX) - Get Report

, which returned 45% in 2009. The fund follows a purely mechanical strategy. Screening through more than 10,000 U.S. and foreign stocks in the Standard & Poor's Compustat database, the managers look for stocks that are above-average in market value, sales and cash flow. From that group, the fund takes the 50 stocks with the highest dividend yields.

Because yields rise when shares fall, the fund includes many unloved stocks. But the screens aim to avoid trouble by limiting the field to big, solid businesses. By focusing on out-of-favor stocks, with sizable dividends, the fund aims to outdo the S&P 500 while delivering rich income. Most often, Hennessy has succeeded. During the past 10 years, the fund has returned 3.5% annually, outperforming the S&P 500 by 4.5 percentage points.

Hennessy currently has a big stake in materials and mining stocks. Holdings include

Rio Tinto

(RTP)

, which mines for coal and iron ore, and aluminum giant

Alcoa

(AA) - Get Report

.

Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.