Mutual Fund Award Predicts Future Winners - TheStreet

NEW YORK (

TheStreet

) -- Plenty of business organizations give awards -- most of them forgettable.

But investors shouldn't ignore the mutual fund industry's best-known prize, Morningstar's manager of the year. Nearly all the winners have had long track records for delivering top returns. Should you consider buying a fund after the manager wins the prize? Yes. Most often winners have gone on to deliver strong returns.

Every year, Morningstar presents prizes in three categories: domestic equity, international and bonds. To size up the contest, I looked at the winners for the 10-year period beginning in 1995. The results were impressive. Of the 30 recipients, 22 outperformed their categories during the three years following the awards.

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Among the notable winners were Rudolph-Riad Younes and Richard Pell of

Artio International Equity

(BJBIX) - Get Report

. After taking the title in 2002, they went on to outperform foreign large blend competitors by 3 percentage points annually during the next three years. Other winners that surpassed their peers by more than 3 percentage points included Joel Tillinghast of

Fidelity Low-Priced Stock

(FLPSX) - Get Report

, which won in 2002, and the managers of

Vanguard Primecap

(VPMCX) - Get Report

, recipients in 2003.

It's especially remarkable that some winners have remained near the top of the pack for long periods. After winning the title in 1998, Mark Yockey of

Artisan International

(ARTIX) - Get Report

went on to outdo his competitors by 4 percentage points annually for the next decade. Donald Yacktman won the prize in 1991. In 1992, he launched

Yacktman Fund

(YACKX) - Get Report

, which has beaten 99% of its large value competitors during the past 15 years.

Morningstar emphasizes that the prizes are given to recognize lifetime achievements and shouldn't be seen as predictions of future performance. Still, the contest relies on sound criteria that have pinpointed worthwhile funds.

In some key respects, the Morningstar method differs from the common strategies used by many investors. For starters, the Morningstar analysts pay little attention to simple past performance, which can be misleading. Instead, they look for funds that "have made a lot of money for investors." Morningstar focuses on a measure called investor returns, which is the result achieved by each dollar in a fund.

To appreciate the importance of investor returns, compare two funds,

T. Rowe Price Mid-Cap Growth

(RPMGX) - Get Report

, the domestic stock winner in 2004, and

CGM Focus

(CGMFX) - Get Report

, one of the top-performing funds of all time. During the 10 years ending in November, CGM returned 19% annually, outperforming 99% of its large growth competitors. But the fund recorded annual investor returns of minus 11%, a result that trailed 95% of competitors.

This occurred because CGM is erratic. During certain periods, the fund soared, and shareholders raced to invest. Unfortunately, much of the money arrived just as the portfolio was peaking. Many of the new investors soon recorded big losses and sold their shares. As a result, the average dollar invested in the fund suffered a loss.

In contrast, T. Rowe Price Mid-Cap returned 6.3% annually during the decade, and shareholders recorded investor returns of 6.2%. The fund achieved a winning record by delivering steady results. Investors held through thick and thin, making real money. That kind of performance is applauded by Morningstar. Volatile funds such as CGM can never expect to the win the Morningstar prize, and most investors should steer away from erratic performers.

Besides looking for strong investor returns, Morningstar favors managers who invest in their own funds. A big ownership stake by a manager represents a vote of confidence, says Russel Kinnel, Morningstar's director of mutual fund research. Managers tend to invest in solid funds with low fees. When fees are high and performance is shaky, managers steer clear.

To find out how much a manager has invested, you can check the statement of additional information, which is available on many fund Web sites. The manager holdings are listed in rough numbers, such as $50,001 to $100,000. Most managers don't invest a penny in their own funds. The managers may not be gifted stock pickers, but they're smart enough to avoid mediocre investments.

Investors who prefer a confident manager should consider David Herro of

Oakmark International

(OAKIX) - Get Report

, who won the prize in 2006 and has more than $1 million of his own money in the fund. When a manager eats his own cooking, the odds are good that he will keep fees low and try to limit the tax bills faced by shareholders. That can help investors achieve sound long-term returns.

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