Concentrated Funds for Bull, Bear Markets

Forester Value Fund ( FVALX) returned 0.4% last year and won a place in the record books. Of more than 4,500 domestic equity funds tracked by Morningstar ( MORN), Forester was the only one to finish in the black for the year.

While luck surely played a role in the winning performance, it shouldn't be surprising that Forester finished in the top ranks. The fund has long followed a pattern, excelling in downturns and lagging during good times. In 2002, a year when the S&P 500 lost 22%, Forester returned 5.7% and outdid 99% of domestic equity funds. The fund finished near the back of the pack in 2006, a year when the S&P 500 returned 16%.

Forester delivers extreme results partly because it keeps a concentrated portfolio, typically holding about 40 stocks. In contrast, most domestic equity funds hold more than 100. Because they place big bets on a few names, concentrated funds like Forester can be volatile, leading one year and lagging the next.

Many investors use concentrated funds the wrong way, buying when they are hot and selling as soon as the managers suffer an inevitable cold spell. But concentrated funds can make sound holdings if they are held for long periods. A fund like Forester can help to diversify a portfolio, cushioning downturns.

To get the best results from a concentrated fund, pick one with a strong long-term record and make sure that you understand how the manager has fared in various market conditions. Some concentrated funds resemble Forester and do well in downturns. Top choices for hard times include value specialists, such as Osterweis ( OSTFX) and Yacktman Focused ( YAFFX). On the other hand, some concentrated growth funds lead in bull markets and trail in bear markets. This group includes CGM Focus ( CGMFX) and Janus Twenty ( JAVLX).

During most years, the results of the growth and value concentrated funds diverge widely. For example, Janus Twenty returned 36% in 2007, outperforming 99% of its large growth competitors. In the same year, Forester lost 5.2% and lagged behind 89% of its large value peers. While Forester stayed in the black during 2008, Janus Twenty lost 42% of its value and trailed 63% of its competitors.

So far in 2009, both funds are running true to form. With many growth stocks rebounding, Janus Twenty has returned 15% through July 7, exceeding 94% of its competitors. Forester has dropped 1.9%, falling short of the S&P 500 by a fraction of a percentage point.

For all the ups and downs, Janus and Forester have delivered winning results over longer periods. During the past five years, Janus has returned 5.4% annually, surpassing 99% of its rivals. In the same period, Forester gained 3.8%, better than 99% of its peer group.

Forester does especially well in downturns because portfolio manager Tom Forester often takes defensive moves when stocks seem about to collapse. A diehard value investor, he typically buys stocks with single-digit price-to-earnings ratios. During periods of declines, he holds cash and emphasizes blue chips, stocks that can survive recessions.

Last year, Forester held as much as 30% of assets in cash. He focused on high-quality companies such as 3M ( MMM) and Microsoft ( MSFT). While those stocks had fallen to bargain levels, the companies still had rock-solid balance sheets and the ability to grow over the long term, Forester says. "When we saw that there would be extreme problems in the mortgage markets, we took extreme measures to protect shareholders," he says.

In recent months, Forester has grown more optimistic about the markets. He has lowered his cash position and begun buying companies that will benefit sharply from a rebound in the economy. A favorite holding is Hewlett-Packard ( HPQ). Computer sales are depressed now, but they should revive eventually, Forester figures.

Like Forester, Osterweis hits the brakes when trouble appears. Last fall, the fund sold financials and shifted to cash. Manager John Osterweis remains wary, still keeping about a third of assets in cash and bonds. The caution has helped limit losses in bad years. Osterweis outperformed 99% of its mid-cap blend competitors in 2002, and last year the fund surpassed 89% of peers. During the past five years, Osterweis has returned 2.3% annually, beating 95% of competitors.

Osterweis prefers undervalued companies with good cash flows. The fund owns only about 30 stocks. In many cases, the holdings face problems, and investors expect the businesses to achieve little growth. Osterweis buys when he thinks a company can surprise Wall Street.

A favorite holding is NV Energy ( NVE), a power producer in Nevada. The shares were pummeled when investors worried that housing problems would hurt Nevada's economy and reduce demand for power. But Osterweis says the company remains on solid footing. "As long as people are in Nevada, they are going to have to turn on the lights," Osterweis says.

Another holding is Unilever ( UN). The consumer giant has suffered from weak profit margins. But the balance sheet remains strong, and the company is moving to cut costs and boost earnings. Osterweis figures that Unilever can grow, even during a period when the global economy may be weak.
Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.