Is That Your Sugar Daddy?

Welcome back to another edition of Foolish mutual fund basics. This time, we're leaving behind the hip hideout of the R-squared ratio for the sugar shack where fund managers live. Ready to get started? Good.

What it is
If the prevailing research is correct, you'd do better paying a monkey to throw darts at the business pages than you would handing your savings to the average fund manager. That's why you shouldn't. But eschew all funds forever? That's just as silly.

What's a Foolish investor to do? Either index, or invest alongside a superior stock picker. But how do you find a market-beating manager? Motley Fool Green Light co-advisor Shannon Zimmerman, who also runs our Champion Funds service, has some ideas.

"First, you'd want to know if the manager sticks to his strategic knitting through thick and thin or whether he's a finger-in-the-wind type," Shannon wrote in an email response to me. "Smart, long-tenured managers know how their strategies will play out in up markets and down -- and how to take advantage no matter which way the winds are blowing."

How it works
Sounds good, doesn't it? Of course it does. But it requires some work to figure out whether you're investing with a committed moneymaker. The best approach may be to read the manager's letters to shareholders from the last several quarters and years.

Therein, the best stock pickers will do more than explain recent performance. They're also likely to comment on top portfolio holdings, and what opportunities have arisen as a result of following a specific strategy. Conversely, those who spend an inordinate amount of time praising -- or, worse, complaining about -- market conditions are more likely to be among Shannon's "finger-in-the-wind" coterie.

That's not Bill Nygren of Oakmark (FUND: OAKMX  ) . In his most recent letter to shareholders, dated Sept. 30, he wrote about how he and partner Kevin Grant view portfolio management. The goal? Give comfort to investors who'd like to understand how Nygren and Grant produce a mix of holdings they believe will beat the market.

Among their most recent big bets are Intel (Nasdaq: INTC  ) , Home Depot (NYSE: HD  ) , Texas Instruments (NYSE: TXN  ) , and Wal-Mart (NYSE: WMT  ) .

Why should Nygren spend time explaining himself? Because he's an investor, too. The bulk of his liquid net worth is invested in Oakmark's funds. That's an important indicator. "When it comes to gauging whether a manager has the courage of his convictions, few fund data points will tell you more than that one," Shannon says.

Go under the hood
Checking up on a manager requires some legwork, but most of it can be done in about 15 minutes. Start by checking the fund's profile at Morningstar. The "Management" tab will reveal the tenure of the team at the top. (Five years or more is ideal.)

Next, check the letters. Most fund shops will post all of their managers' writings on their websites. Oakmark, for example, has a commentary section for each fund it sells. I found Nygren's letter within two minutes of visiting the site.

Then comes to the hard part. Checking up on your manager's ownership commitment requires a copy of the "statement of additional information." Therein, the SEC requires him or her to disclose roughly how much of his or her liquid assets are invested alongside you.

That's the good news. Here's the bad: Not many funds make the statement of additional information available on their websites. Most will instead make you call an 800 number or search the SEC's EDGAR database. Still, it's worth the effort to know whether you're betting on stock pickers who, as Shannon says, eat their own cooking.

Follow the money
Most funds, and most fund managers, aren't worth the money. For many, that's a strong argument for indexing. Not me. I've profited from managed funds in the past and plan to do so again. If that's you, too, then take Shannon's advice and get to know your stock picker before you invest a dime. That's the surest way to know whether you're shacking up with a sugar daddy or (gulp) investing with the enemy.

Interested in more moneymaking tips? Consider Motley Fool Green Light. Shannon and co-advisor Dayana Yochim are offering 30 days of free access to the service right now. Click here to get started.

Interested in more mutual fund basics? Your digital chariot awaits:

Only three days left in this season's Foolanthropy campaign! Visit www.foolanthropy.com to learn about five reader-nominated charities and make a donation.

Fool contributor Tim Beyers, ranked 1,320 out of more than 19,200 in Motley Fool CAPS, didn't own shares in any of the companies mentioned in this article at the time of publication. Get a peek at everything he's invested in by checking Tim's Fool profile. Home Depot, Intel, and Wal-Mart are all Inside Value selections. The Motley Fool's disclosure policy is your portfolio's sugar daddy.


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