There’s a reason why folks like Warren Buffett and George Soros are so carefully scrutinized by the investing community: they’ve made billions of dollars for themselves and for their investors. Fortunately, there are a decent number of other money managers out there who can also beat the market on a regular basis, including one who has just risen to the top of the heap.
The new king
According to Morningstar data, there is a new top stock picker of the decade: Thomas Soviero, who runs the $4.5 billion Fidelity Leveraged Stock Fund (FLVCX). His fund has posted a 15% annualized return over the past 10 years, the highest among all diversified U.S. stock funds. Soviero has unseated Ken Heebner, whose CGM Focus Fund (CGMFX) previously held the number one position for 11 quarters. CGM Focus recently fell to ninth place in the race. In comparison, the S&P 500 has posted an annualized 10-year return of just 3.3% through the end of March 2011.
While both Heebner and Soviero deserve much credit for beating the market by such a wide margin, it helps to take a closer look at both of these funds and how exactly they are generating these returns. Both funds are highly volatile and are prone to producing dizzying highs one year and hefty drops the next. It makes sense if you think about it; the way to produce higher returns is to take on more risk. I won’t argue that both men aren’t talented stock pickers. But that doesn’t mean that the funds they manage are right for every investor.
Bad credit? No credit? No problem!
The key to Fidelity Leveraged Stock’s success has been Soviero’s ability to find debt-laden companies with poor credit that have the potential to outperform expectations. Soviero worked on the high-yield bond side at Fidelity for several years before moving over to run Leveraged Company Stock in 2003. Right now, he is overweighting materials and industrial names in the portfolio with the belief that these companies should benefit from a recovering economy and from a weaker U.S. dollar, thereby making their products more competitive in the global marketplace. In this sector, picks such as Peabody Energy (NYSE: BTU ) , chemical manufacturer Celanese (NYSE: CE ) , and glass fiber producer Owens Corning (NYSE: OC ) are favorites in the portfolio right now.
But investing in heavily indebted companies is not without risk. During the financial crisis, Leveraged Company Stock lost nearly 55% of its value in 2008, sharing the fate of many funds that invested in more speculative companies. True, the fund bounced back with a 60% gain in 2009 and a further 25% return in 2010, but the risks here are obvious. Not to mention that a huge part of the fund’s trailing 10-year return is being driven by its outsized 96% gain back in 2003. Clearly, that’s not a return investors should expect every year!
Given that this fund focuses on more mid-sized firms, it’s not surprising that it’s beating the market, as mid-caps have been the best-performing domestic stock asset class in that time. This fund is a good choice for adventurous investors who can ride out volatility and stomach heavy losses, but not for more moderate or conservative types who want a smoother ride.
Go big or go home
Likewise, Ken Heebner’s CGM Focus is another exercise in taking on risk to win big. The fund is fairly concentrated, with just 20 holdings and an allocation to only a few market sectors. As of the most recent data available, top holding Ford (NYSE: F ) soaked up 19% of fund assets. Fund data also show that Heebner is leaning heavily into lower-P/E consumer cyclical names such as automotive part suppliers Magna International (NYSE: MGA ) and AutoZone (NYSE: AZO ) . But given the fund’s incredible 363% annual turnover, it’s anyone’s guess what the portfolio looks like now.
Performance here has also been a roller coaster ride. The fund lost 18% in 2002 but gained 66% the following year. It posted an eye-popping 80% return in 2007, but fell 48% in 2008. The fund ranks in the top 1% of all large growth funds over the past 10 years, but ranks in the bottom 1% of that same peer group over the most recent 3-year period.
Heebner bets big, and while his bets have generally worked out over the long run, there will be long stretches of time where they don’t, making it a difficult fund for many investors to own. If you are willing to take on a hefty amount of risk and are willing to sit through long stretches of underperformance, CGM Focus might work for you. But most folks won’t have the patience, and will simply buy in when performance is good and sell when things turn south, defeating the purpose of buying for the long haul.
Ultimately, both of these funds have been successful at beating the market over the long run. But investors need to dig a little deeper and look at how these funds are doing what they’re doing. Funds that rise to the top of the pack likely have the wind at their backs and have just come off of an environment conducive to their specific investing style. Odds are better that the fund will sink back down to the bottom than that it will continue to stay at the top. Top-performing funds can be good buys, but only if you look at the bigger picture first and stick with them over the years.