2 Winning Large-Growth Mutual Funds

NEW YORK ( TheStreet) -- Mutual funds in the large-growth category have taken investors on a rough ride in recent years.

During the turmoil of 2008, the average fund in the group lost 40.7%, lagging the S&P 500 by 3.7 percentage points, according to Morningstar. As investors worried about the euro crisis in 2011, the funds lost 2.5%, trailing the S&P by more than 4 percentage points.

For steadier performance, consider two intriguing mutual funds, Gerstein Fisher Multi-Factor Growth Equity ( GFMGX) and Rydex S&P 500 Pure Growth ( RYLGX). The funds have outdone their average peers and excelled in downturns. While they follow different strategies, both funds have succeeded by tilting toward the smaller members of the large-growth stock universe.

Gerstein Fisher is an actively managed fund that uses a computerized model. During the past three years, the fund returned 12.5% annually, outdoing 82% of peers.

Portfolio manager Gregg Fisher starts with a broad collection of large growth stocks. To boost results, he underweights the biggest stocks. The strategy is based on studies showing that small stocks outdo large ones over time.

The average stock in his portfolio has a market value of $20.1 billion, compared with $37.6 billion for competing funds. To maintain diversification, he does not allow any stock to account for more than 5% of the portfolio. "When Apple ( AAPL) rose to be more than 5% of the benchmark, we underweighted it," he says.

Besides tilting away from the biggest stocks, Fisher eliminates some of the most expensive names in the group. As a result, Fisher's portfolio has a price-to-earnings ratio of 13.9, compared with 18.7 for the average fund in the category. The idea is that shares with high P/E ratios tend to be volatile high-flyers that can crash suddenly. Many studies have shown that expensive stocks underperform.

Fisher overweights momentum stocks, which have rising prices. The strategy is based on the idea that momentum stocks tend to keep rising, while declining issues continue to underperform. "Investors like to buy winners," he says. "So momentum stocks have worked well in markets around the world for the last 50 years."

Like Fisher, the Rydex fund has produced winning results by emphasizing the smaller members of the large growth universe. During the past five years, Rydex has returned 9.2% annually, outdoing 94% of peers and topping the S&P 500 by more than 3 percentage points.

Rydex is an index fund that tracks the S&P 500 Pure Growth benchmark, which includes one-third of the S&P 500 with the strongest growth characteristics. To pick the members of the index, S&P researchers score the stocks according to several indicators, including price momentum, earnings growth and P/Es. The approach differs from typical growth index funds, which search for stocks in the growth half of the index. By only taking the purest growth stocks, the S&P index eliminates some big blue-chips that tend to be slower moving.

The Rydex pure fund does not own Microsoft ( MSFT) or Coca-Cola ( KO), big holdings in Russell 1000 Growth index. Instead, the Rydex pure growth fund emphasizes more mid-cap stocks, which often have faster earnings growth. Sizable holdings in the Rydex fund include such smaller stocks as Southwest Airlines ( LUV) and Netflix ( NFLX).

During growth rallies, the Rydex pure fund is likely to outdo Fisher's fund. But the pure growth fund is also more volatile and has lagged Fisher in downturns. In the rough markets of 2011, the Rydex fund lost 1.2%, trailing Fisher by about 3 percentage points. Either fund offers an intriguing option for investors seeking a better way to diversify portfolios.

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

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