Savvy investors like to point out that the typical mutual fund loses out to the broader market over the long haul. Legg Mason Value Trust (FUND:LMVTX), which finished 2004 with its 14th consecutive market-beating year, is an outlier, they argue. Heck, even if actively managed funds do edge past index trackers such as Spiders (AMEX:SPY), Vanguard Total Stock Market VIPERs (AMEX:VTI), and Fidelity Spartan 500 (FUND:FSMKX) over certain periods, the odds of that winning streak continuing are slim to none.

Top dogs
Those savvy types are at least partly right. Thanks to low costs and superb tax efficiency, passively managed index trackers do have built-in advantages that the typical fund -- with much higher overhead and a tendency to flip stocks at a gains-draining clip -- can't possibly match.

But investor beware: There's less to that observation than meets the eye. For starters, who ever said you have to invest in the "typical" fund? After all, the "typical" individual stock is a bad bet, too. Yet people still buy stocks. And if finding the Value Trusts of the world ain't exactly easy like Sunday morning, it's not an impossible dream, either -- in fact, that's exactly what we aim to do at Champion Funds.

Consider the case of Dodge & Cox International Stock (DODFX), a fund whose portfolio recently featured the likes of GlaxoSmithKline (NYSE:GSK), Sony (NYSE:SNE), and Honda Motor (NYSE:HMC). Since I recommended it to subscribers in our June 2004 issue, the fund has sprinted to a gain of more than 33%, a mark that leaves the S&P 500 behind by more than 28 percentage points. And while foreign equities have had a good run over the period, the fund has spanked the international MSCI EAFE index, too.

Another Champ, one with a price tag of just 1.12%, has trumped the S&P by more than 18 percentage points en route to a total return of nearly 20% since I recommended it.

Not too shabby, eh?

What it takes
To be sure, while digging up similarly winning market beaters may not be easy, it's not rocket science, either. To make the grade (and stack the odds in your favor), a fund needs a clutch of key attributes -- the kinds of things that any smarter-than-average investor should bear in mind.

Low costs are essential. As I do my homework for Champion Funds, those with loads or luxury price tags go directly to the reject pile. Beyond that, I'm on the hunt for funds that come with seasoned managers who have successful track records of beating the S&P 500 over time, and with a sound stock-picking strategy to boot. Top-down types who make big, risky bets on "hot" sectors need not apply. And funds with managers whose approach to picking stocks changes with Mr. Market's moods also don't make the cut. When it comes to fund investing, the answer, my friends, isn't blowing in the wind.

Moreover, while I'm a big fan of diversification, I generally steer clear of funds that water down their managers' best ideas with hundreds of picks to "control" risk. That way lies mediocrity.

Scandalous scandal
These days, any search for the fund industry's best and brightest has to include an ethics test, too. New York Attorney General Eliot Spitzer's investigation confirmed some of our worst fears about the fund industry. And if many of the implicated shops have shaped up, I think it's still too soon to let bygones be bygones.

Indeed, these tainted firms will have to prove over time that they've clamped down on the permissive corporate cultures that allowed serious trading abuses to occur. Good intentions are great, but investors should insist on real results.

A silver lining
For all that, I'm pretty optimistic about the prospects for industrywide reform. Though the SEC is dragging its feet on the matter, mandatory redemption fees (which discourage market timing) are still on the table, as are strict curbs on nefarious "soft-dollar arrangements." And beginning this year, investors will be able to learn if their manager "eats his own cooking" by investing in the funds he runs -- a great gauge of whether a manager's interests are truly aligned with his shareholders'.

Even better, while we're all waiting impatiently for the fund industry to reform itself, there's no need to sit idly by. Solid, market-beating funds -- Champion Funds -- are out there for the picking. You just have to know where to look.

See you in the winner's circle!

Now what?
You can beat the market -- with funds! Take a free trial of Motley Fool Champion Funds.

This article was originally published on March 25, 2004. It has been updated.

Champion Funds analyst Shannon Zimmerman owns shares of Vanguard Total Stock Market (VTSMX), the mutual fund version of the ETF mentioned above. The Motley Fool has a disclosure policy.