Louis Lowenstein, a buttoned-down 81-year-old emeritus finance and law professor, is positioning himself to become the mutual fund industry's most urbane critic. Listening to him talk about his book in progress, which he promises will uncover the shame of the fund industry, is like watching a man sharpen his sword to do battle with a tank. One can't help but wish him well.
Over the last two years, Lowenstein has given speeches and written articles that parsed the performance of the industry's largest funds and found them lacking. He found that a group of value funds run by buy-and-hold investors beat the largest funds from household-name fund companies repeatedly. The value investors he studied also avoided buying almost all the bubble-year debacle stocks. (Although one bought Nokia Corp. and sold it for a 1,900 percent profit.)
In a January paper he wrote for The Center for Law and Economic Studies at Columbia Law School, which later became an article for Barron's, he compared 15 large-cap growth funds to 10 value funds.
The large-cap growth funds, which were chosen because they were the largest in assets at year-end 1997, had negative returns of 8.89 percent a year for the five years ending Aug. 31, 2005, a bigger drop than the 2.71 percent drop experienced by the Standard & Poor's 500 during the same period. But the 10 value funds Lowenstein had positive returns of 9.83 percent for the period.
Lowenstein's 10 value funds were recommended to him in 2004 by Robert D. Goldfarb, the chief of The Sequoia Fund, which itself has all the characteristics Lowenstein finds admirable in a fund. (It's closed to new investors.)
The funds were Clipper Fund, FPA Capital, First Eagle Global, Mutual Beacon, Oak Value, Oakmark Select, Longleaf Partners, Legg Mason Value, Source Capital, Tweedy Browne American Value.
Of the 10, six are open to new investors today: Clipper Fund, Mutual Beacon, Oak Value, Oakmark Select, Legg Mason Value and Source Capital. The fund managers at Clipper and Mutual Beacon left in 2005, and Mutual Beacon is now part of Franklin Templeton Investments.
Asked this month for funds he'd recommend, Lowenstein mentioned Fairholme, Longleaf Partners International, FPA Perennial and FPA Paramount and Oakmark Select.
Managers of these funds have discipline, patience, long-term perspective and, for want of a better word, a sense of fiduciary duty, he said in an interview at his Central Park West apartment. They're investing in companies, not markets.
Lowenstein quotes Jean Marie Eveillard of First Eagle Global, whose investors excoriated him for sitting out the boom stocks of the go-go years. Eveillard responded, I would rather lose half my shareholders than lose half my shareholders' money.
Still, the funds are for long-term investors who are not afraid to lose money _ sometimes lots _ in the short term.
Longleaf Partners International, which just reopened to investors on June 10, lost 16.5 percent in 2002. Investors who bailed out then had plenty of time to kick themselves later: The fund gained 41.5 percent in 2003. Oakmark Select has a 5-year average annual total return of 6.60, but lately it's been in the dumps. Its year-to-date return is 1.73 and it was down 0.77 percent for the three months ended June 30.
Lowenstein's favorite funds invest using a bottom-up strategy: They do intensive research to find good companies at low prices. Benjamin Graham, the intellectual godfather of all value investors, called this a margin of safety.
The funds tend to buy a limited number of stocks, making a few big bets on companies they've researched intensively.
You get to know the business and the management and the balance sheet, Lowenstein said, pointing to Bill Nygren, fund manager of Oakmark Select, who has said that he won't hold more than 20 stocks, so investors get his 20 best ideas. As of March 31, 15.27 percent of Oakmark's net assets were invested in Washington Mutual Inc. and another 7.25 percent were invested in Yum! Brands, Inc.
Most of the value funds focus on a few large companies. Some stocks held by more than one of the funds include Warren Buffett's Berkshire Hathaway Inc. and Tyco International Ltd., the conglomerate that has spent the last three years emerging from scandal.
The managers invest heavily in the funds themselves, something they call eating their own cooking. We put our money where our mouths are by investing in the Fund and our investors' money will never be used to test ideas not bonded by our own wealth, The Fairholme Fund's Web site says.
The funds eschew turnover, buying companies they like and holding on to them. Most of the funds tend to stay relatively small, closing before they get so big that their movements move the market.
Lowenstein is quick to say that his list is short, but you don't need many, he said.
It's like picking stocks; one or two good managers are all you need.