These Underperformers Deserve a Second Look

When it comes to the world of mutual funds, performance is everything. While process and management are vitally important parts of fund analysis, in the end, what investors want is to make money. After all, if you're going to be paying fees for active management, you want to see results. You can have the best management team in the world, but if your fund isn't making money -- and beating the market -- investors aren't going to have much interest.

Even though a long-term investment program calls for a long-term focus on results, most folks are notoriously short-sighted. If a fund stumbles in any given year or two, odds are a fair number of investors are headed out the door. Fund investors certainly aren't known for their patience, but in some cases, waiting out a stretch of bad performance can pay off in the long run. Some funds are still excellent options with solid long-term prospects even though recent returns have fallen short -- and here are two prime examples of just that type of fund.

Brandywine (BRWIX)
There are losing streaks, and then there are serious losing streaks -- and lately Brandywine has embarked on the latter. Over the past 15-year period, the funds has put up an annualized 4.1% return, placing it squarely behind 96% of all mid-cap growth funds. While the fund's returns actually looked fairly decent prior to 2008's bear market, management ran into come serious trouble in the aftermath of the recent recession. The fund lost 44.5% in 2008, which isn't too far off the mark for many equity funds.

While most funds rebounded nicely in 2009 and 2010, Brandywine continued to lag, trailing the average mid-cap growth fund by 30.5 percentage points in 2009, 3.5 points in 2010, and 12.1 points in 2011. Assets in the fund have dropped significantly, to around $1.3 billion, as investors have thrown in the towel.

But investors who write Brandywine off now may be missing out down the road. The fact remains that Brandywine has a solid, if somewhat high-turnover investment process behind it. The fund has been headed up by Bill D'Alonzo since its 1985 inception, and he has a solid history of making successful investments with this approach. Management follows an earnings momentum strategy, where the fund attempts to profit from companies that exceed earnings expectations. There's a lot of movement here -- turnover is 234% a year, so this is a fast-moving strategy. Unfortunately, this strategy hasn't proven effective in the market environment of recent years. The market favored more speculative, lower-beta investments in 2009 and 2010, leaving a fund like Brandywine that focused on higher-quality securities out in the cold. And such a strategy was largely powerless in 2011's high-volatility market, where stocks moved largely in lockstep and individual stock picking wasn't rewarded by the market.

But ultimately, I think there are better days ahead for Brandywine. The fund's process has taken a beating, but it has proved successful in the past and should do well as more normalcy returns to the markets and companies that consistently beat earnings are once again rewarded. In fact, the portfolio has benefited from tech holdings such as Apple and eBay, which are both up substantially in 2012. Overall, the fund is beating the market and the average mid-cap growth fund so far this year. There's a lot to like here, so don't let a few years of bad relative performance scare you away -- Brandywine still has the potential to be a long-term winner.

Muhlenkamp (MUHLX)
Muhlenkamp is another former highflier that has fallen on harder times as of late. While the fund boasted an excellent track record just a few years ago, recent stumbles have begun to pull down long-term performance. Longtime manager Ron Muhlenkamp get burned in 2006 and 2007 with his outsized bets on housing stocks, causing his fund to trail the S&P 500 Index by 11.7 percentage points in 2006 and 15.2 percentage points in 2007. Muhlenkamp also added to his stash of higher-quality names back in 2010 just as riskier, more speculative stocks were gaining favor in the market. The fund's hefty cash stake at this time also weighed on returns as the market roared back to life. As a result of these missteps, the fund's trailing 10-year annualized performance fell to 1.7%, putting it behind 95% of all large-value funds.

However, Ron Muhlenkamp has a tremendous history as a skilled investor and will likely lead his fund back into the spotlight before long. Even with the underperformance of the past few years, the fund still ranks in the top 27% of its peer group over the past 15-year period. Looking ahead, Muhlenkamp has a great portfolio, chock-full of low-priced, dividend-paying stocks like Microsoft and Intel. With the renewed market focus on dividend payers and a potential resurgence in stable, large-cap blue-chip names, this fund is well positioned to take advantage of future trends. Volatility isn't likely to dissipate here, but patient investors with a long-term focus should do well with this fund.

A lesson learned
So why should investors give either of these underperformers a second look? Well, for one, both possess skilled managers that have proven their abilities over the long haul. While recent performance has definitely been unimpressive and has begun to affect each fund's long-term track record, the important thing is to look forward at what the fund is likely to do in the future. Far too many investors dump their funds at the first sign of underperformance, and when the fund bounces back, they pile back in. But at this point, it's too late -- they've missed the rebound.

Fund investing requires a long-term outlook, which means you've got to ignore short-term fluctuations. It's not easy to hold on to good funds when they temporarily stray off track, but it's vital to winning at the investing game. If your fund was a good one before it started underperforming, it's probably still a good fund and worthy of your investment dollars. So before you push the sell button, take a second to make sure you're not prematurely selling a long-term champ -- you could end up losing out in the end.

Even if your portfolio hasn't fallen prey to underperformance in recent years, your retirement could still be at risk. Be sure to check out our newest special free report, which highlights the shocking truth about your retirement. Don't miss this chance to grab your free copy of this can't miss report today!

Amanda Kish is the Fool's resident fund advisor for the Rule Your Retirement investment newsletter. At the time of publication, she did not own any of the funds or companies mentioned herein. The Fool owns shares of Apple, Microsoft, and Intel. Motley Fool newsletter services have recommended buying shares of Apple, eBay, Microsoft, and Intel, as well as creating bull call spread positions in Apple and Microsoft and writing puts on eBay. 

Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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  • Report this Comment On May 31, 2012, at 11:12 PM, cbaines2 wrote:

    "The market favored more speculative, lower-beta investments in 2009 and 2010"

    Don't you mean higher-beta?

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