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Investing September 4, 2008, 5:00PM EST

When a Fund Loses Its Star

(page 2 of 2)

First Eagle manager Eveillard had to replace his first successor with a new one Brendan McDermid/Reuters

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Patel had also left the fund with 18% in equities, the maximum allowed in the prospectus. Selling off several hundred million dollars' worth of stocks was easier. Feltus and Wright dropped the equity stake to 12% within a few weeks, lessening the impact of the market's tumble this summer.

Not all of the pair's initial moves worked out as well. Last summer they sold some corporate bonds and used the money to buy bank loans from the same companies. Yields were about equal, even though bank loan holders have a much stronger claim than junk bond investors on a company's assets in bankruptcy.

Unlike junk bonds, which pay a fixed rate of interest, rates on bank loans are pegged to the Federal Reserve's benchmark interest rate. So when the Fed cuts rates, holders of bank loans get paid less yield and the value of their loans suffers. Last year, with the market anticipating continued Fed cuts, investors sent values of bank loans skidding. Feltus and Wright dropped the strategy. Now the Fed is moving toward raising rates and Pioneer is buying some loans again. "I'm not investing for the next 30 days," says Feltus. "I'm looking at the next two years."

KEEPING TALENT ON DECK

Funds with established succession plans can largely avoid dramatic overhauls. Some firms assign up-and-coming managers as understudies for years or keep a deep bench of seasoned analysts. When value investing legend Jean-Marie Eveillard first retired in 2004, for example, his replacement at First Eagle Funds was Charles de Vaulx, who had spent 16 years at the company. The younger man was named Eveillard's co-manager in 1999. When he took over, there was little change in style, and the funds performed well over the next few years.

But even a well-planned transition plan can go awry. Eveillard, enjoying his retirement in Paris, got a surprise call last March telling him de Vaulx had suddenly resigned. (He later joined New York-based International Value Advisers.) Eveillard rushed back to New York to take over the First Eagle funds again and start a new search for a successor. In July, he named Matthew McLennan, a London-based fund manager for Goldman Sachs' (GS) private clients, to run his biggest fund, the First Eagle Global Fund (SGENX).

Some companies take steps to avoid transitions altogether by creating teams of managers. At top-selling American Funds, assets are divided between as many as a dozen managers. Dodge & Cox uses a group of managers who work together to pick stocks. Vanguard Group actually splits large funds among outside management firms that can be replaced as needed.

Fidelity takes a different approach, often cycling analysts through industry sector- focused mutual funds to train them to manage more diversified funds. When Neal Miller stepped down two years ago as manager of the Fidelity New Millennium Fund (FMILX) after 13 highly successful years, he was succeeded by John Roth, an analyst who had run several sector funds over the previous seven years. Miller had been a top-notch trend spotter, making big bets on industries ahead of most investors. He was buying Internet stocks in 1995 and sold most before the bubble burst. Roth has run the fund in a more conventional manner and lagged similar funds by about one percentage point a year since taking over, according to Morningstar. Fidelity says the fund's goal is to outperform the Standard & Poor's 500-stock index, which it has done, gaining 4.9% since Roth took over vs. a 3.9% gain for the index.

Over at the Pioneer (TAHYX) High Yield fund, the managers are hopeful. Outflows have slowed, and while neither manager expects a quick turnaround to the credit crisis, they note that junk bond investors are being paid for taking on risk. Junk bonds now pay about eight percentage points more yield than U.S. Treasury bonds for the same maturity. That compares favorably with a premium of less than three points when the duo first took over. Says Feltus: "We think U.S. high yield is the place to be."

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Pressman is a correspondent in BusinessWeek's Boston bureau.

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