The same careful investing approach that won Thomas Perkins an enviable long-term record has given his Perkins Mid Cap Value mutual fund a disappointing 2010.
The $13.3 billion fund, the largest in its category, closes to new investors at the end of the year. It is the best performing midcap stock fund since its inception in 1998, according to Morningstar (MORN) data. The Perkins fund has produced an average annual return of 13 percent, despite two recessions and a decade of the worst annual returns for the Standard & Poor's 500 index, which dates to 1927.
Yet in 2010 through Dec. 23, the Perkins Mid Cap Value fund is among the worst performers of its kind, worse than 95 percent of the funds in its category and 7.6 percentage points behind its average peer. Because midcap U.S. stocks had a stellar year, that still works out to a year-to-date gain of 14.6 percent for the fund.
In many ways, Perkins' fund is doing exactly what it tells customers it can offer—some measure of protection when the market turns south. "Investors need to recognize that there will be years when it will lag its peers," says Katie Rushkewicz, a mutual fund analyst at Morningstar, which gives the fund its highest five-star rating. "Investors need to be willing to hold on during those periods and not let that drive their positions."
Despite the off year, Perkins said in a Dec. 22 phone interview that he is not altering his investing strategy, which focuses on companies with strong balance sheets, positive cash flow, and inexpensive valuations.
"The reason it works is that we've outperformed generally in down markets," says Perkins, co-manager of the fund with Jeffrey Kautz. A conservative approach that emphasizes strong companies tends to protect investors from steep losses, making them better off over the long term, he says. "We look at the downside of a stock before we look at the upside."
In 2001 the fund gained 20.5 percent, even as the broad Standard & Poor's 500 index lost 11.9 percent, a performance that put it in the top 8 percent of its category. In the turbulent year of 2008, the fund lost 27.3 percent yet still beat its category by 9.4 percentage points and was among the top 5 percent of funds in its category.
Perkins says one reason his approach faltered in 2010 was because the market has generally favored "lower quality" stocks that he would never consider buying. For example, financial companies that faced the prospect of bankruptcy just two years ago have survived—and subsequently doubled or tripled in value.
Also, wild swings in the market tend to help the fund—allowing Perkins to buy stocks at bargain prices—but much of 2010 has been relatively mild, he says. One measure of volatility is the Chicago Board Options Exchange Volatility Index, or VIX, which in 2010 averaged 22.7 through Dec. 23, down from 31.5 in 2009 and 32.7 in 2008. The VIX fell to a three-year low of 15.45 on Dec. 22. "I would be surprised if volatility doesn't pick up and provide short-term opportunities that we welcome," he says.
Perkins sees "fundamental problems" in the U.S. economy, troubles that could make the stock market far more volatile. "The problems we've got have taken several decades to build, and they're not going to be corrected in a couple years."
Favoring Health Care
For more than six years, the midcap fund has had a higher-than-usual concentration of health-care stocks. Perkins says he likes many health-care companies because of their good balance sheets and cash flow, despite threats to profits from the federal government's looming health-care reform. "There's been fear of regulation for years," he says. "That hasn't dissuaded us from investing in strong companies that are well-positioned and reasonably valued." As the Baby Boom generation ages, the demographics of health care look favorable, he adds.
Nonetheless, the fund has been selling some of its health-related stocks recently, in keeping with an approach of selling stocks when they reach a target price. "That's regardless of how great we think the company is [or] how great we think management is," Perkins says.
The fund has avoided utility stocks, which Perkins says tend to have high debt levels and a "limited opportunity for growth."
In 2010, the stocks of smaller companies have outperformed larger companies. The small-cap Russell 2000 is up 26.2 percent in 2010 through Dec. 23, while the large-cap S&P 500 is up 12.7 percent. Expect that to reverse eventually, Perkins says. "We're finding more opportunities in larger stocks." Perkins and his brother, Bob, also run funds aimed at large-cap, small-cap, and "all-cap" stocks, under the Perkins name and with the fund adviser Janus Capital Management.
Morningstar's Rushkewicz says that closing a mutual fund to new investors is generally a good idea. When funds get too large, it can be hard to find places to invest new money, she says, especially when large purchases of small-cap stocks can significantly move their prices.
"We don't want to have so much in the fund that we can't flexibly invest in smaller stocks when the valuations are attractive," Perkins says.