Man Beats Machine at These Mutual Funds

Mairs & Power and Legg Mason offer large-blend mutual funds that beat benchmarks while keeping risk low.
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NEW YORK (TheStreet) -- Many investors have dumped actively managed stock funds and embraced index funds during the past year. Large-blend funds, which hold growth and value stocks, have been the most popular.

Of the $895 billion invested in the large-blend category, 46% is

index funds

, with the rest in actively managed portfolios, according to

Morningstar

(MORN) - Get Report

. Big funds in the category include

S&P 500

trackers such as the

Fidelity Spartan 500 Index Fund

(FUSEX)

and the

Vanguard 500 Index Fund

(VFINX) - Get Report

.

Some advisers say investors should use index funds for large-blend exposure because few active managers can gain an edge in a category that's dominated by a small number of blue-chip stocks. But some managers have beaten the odds by outdoing the S&P 500 over long periods while taking less risk than the benchmark, as indicated by beta, a measure of an investment's volatility. Because of their caution, the funds are likely to deliver consistent results and shine through downturns.

"If a fund can control risk and still outperform, then it is worth considering," says Todd Rosenbluth, an analyst for

Standard & Poor's

.

A low-risk choice that Rosenbluth favors is the

Legg Mason ClearBridge Appreciation Fund

(SHAPX) - Get Report

. The fund has a beta of 0.82, suggesting that it has lost four-fifths as much as the S&P 500 in downturns.

During 2000, the fund stayed in the black, a notable achievement in a year when the S&P 500 lost 9.1%. In the turmoil of 2008, the Legg Mason fund outdid the benchmark by 8 percentage points.

The fund managers deliver steady results by focusing on high-quality stocks that sell at modest prices. Fund holdings include

Exxon Mobil

(XOM) - Get Report

and

AT&T

(T) - Get Report

.

When the managers can't find any bargains, they let cash accumulate. During 2008, the fund had more than 6% of its assets in cash, a move that helped the managers beat the benchmark.

Rosenbluth says the fund stays broadly diversified, rarely betting on any one industry. The aim is to hold the best stocks in each sector. Although the portfolio has a market weighting in financials, the portfolio is steering away from shaky regional banks and emphasizing solid blue chips, such as

Travelers

(TRV) - Get Report

.

"The managers want companies with strong balance sheets and sustainable business models," says Rosenbluth.

Legg Mason's cautious approach can cause it to lag during roaring bull markets. That happened in 2009. But by avoiding big losses, the fund has returned 8.1% annually during the past 15 years, outpacing 77% of its peers and topping the S&P 500.

Another low-risk choice is the

Parnassus Equity Income Fund

(PRBLX) - Get Report

, which has returned 10% annually during the past 15 years, outpacing 96% of its peers. The fund topped the S&P 500 by double-digit margins during the downturns of 2000 and 2008. Parnassus sticks with high-quality stocks and boasts a beta of 0.85.

Manager Todd Ahlsten looks for dominant companies that can grow faster than the U.S. gross national product because of favorable economic trends. He aims to buy when stocks suffer temporary disappointments and sell at discounts. "We buy great companies at value prices," he says.

A big holding is

Waste Management

(WM) - Get Report

, the operator of landfills and recycling centers. The recession hurt sales, but Ahlsten says the company has long-term growth potential.

"If you own the only landfill in town, then you have a sturdy business," he says.

Another holding is

Qualcomm

(QCOM) - Get Report

, which licenses chips used in mobile devices. Alhsten says that the company can grow for years as the number of cell phones increases around the world.

One of the steadiest large-blend funds is the

Mairs & Power Growth Fund

(MPGFX) - Get Report

, which has returned 12% annually during the past 15 years, outdoing 99% of its peers. The managers aim to buy companies that can grow at high single-digit or low double-digit rates. Why not look for businesses with more exciting prospects? Manager Mark Henneman says that high flyers often crash. "High growth rates are not sustainable," he says. "We are looking for good companies that can grow at a consistent pace for the foreseeable future."

Once he buys, Henneman almost never sells. The fund turns over only 2% of its portfolio annually. In contrast, the average large-blend fund has an annual turnover rate of 80%.

A big holding of Mairs & Power is

3M

(MMM) - Get Report

. Spending heavily on research and development, the blue chip dominates many businesses, says Henneman. He also owns

Emerson Electric

(EMR) - Get Report

, a supplier of factory automation that is expanding around the globe.

--

Reported by Stan Luxenberg in New York

.

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