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Mutual Funds: Six Heads Are Better Than One


If investing is a sport, Ken Gregory's got game. The 43-year-old president of Litman/Gregory Fund Advisors in Orinda, Calif., heads a dream team of money managers at his Masters' Select Equity Fund. After years of interviewing top managers for his newsletter, No-Load Fund Analyst, Gregory decided in 1997 to combine their wisdom in a single fund. The six "masters" running Masters' Select Equity (MSEFX) include value guru Bill Miller of Legg Mason, growth expert Spiros "Sig" Segalas of Harbor Capital Appreciation, and vulture investor Mason Hawkins of Longleaf Partners.

The results have been impressive. As of May 17, Masters' Select Equity had a 10.7% three-year annualized return, vs. just 6.5% for the Standard & Poor's 500-stock index. Two other funds Gregory oversees--Masters' Select International (MSILX) and Masters' Select Value (MSVFX)--have also proved champions. Select International has a 12.9% three-year annualized return, decimating the average foreign stock fund's 2.2%. Newcomer Select Value is up a healthy 18% year to date. The funds' combined assets are a healthy $900 million.

ONLY THE CREAM. Besides strong management, the funds have another powerful weapon: concentration. Each manager can contribute no more than 15 favorite stocks to a Select fund's portfolio. By skimming the cream off their stock lists, the managers have actually performed better on a weight-adjusted basis in Masters' Select Equity and International than in the funds they run at their other companies. Although Gregory declined to disclose any comparative numbers, analysis using Morningstar software confirms this fact.

Gregory is no overnight success. When he and partner Craig Litman founded their investment advisory business in March, 1987, their timing couldn't have been worse. Back then, they were only selling mutual funds, not running them. Litman was a former attorney with a new MBA degree, and Gregory had just a few years of investment consulting under his belt. So when the market crashed that October, they were ill prepared. To generate extra revenue, they decided to start a newsletter about funds with $120,000 they borrowed from Litman's brother and a wealthy friend. They published a test issue of the No-Load Fund Analyst in November, 1989.

But the test readership for the first issue had no interest in buying a second. "When we finally launched the newsletter, our advisory business had reached a point where we knew it was going to survive," says Gregory. "We probably would have forgotten the whole thing if we didn't have to pay Craig's brother back." Instead, Gregory found himself calling several fund managers every month to profile in the newsletter. "Back then, they were surprised to get a call from anybody," Gregory says.

Doing intensive research on each fund, Gregory would choose his favorites for the newsletter's four model portfolios. The investment results were sound--the average portfolio's 10-year annualized return, 12.3%, ranks 16th out of 69 investment newsletters, according to Hulbert Financial Digest. Yet the newsletter has never been a rousing financial success. To date, it only has about 1,500 subscribers. But it has provided Gregory with access to some of the best minds on Wall Street.

That access taught him some valuable lessons. "From our conversations with managers, we came to believe that their conviction level about the stocks they owned was not equal," Gregory says. "If they owned 50 or 100 stocks, there might be only 5 or 10 they felt very confident about." He learned one other painful truth: Even the best managers are often wrong.

COVERING ALL BASES. Those insights gave him the foundation for his multimanager approach. "By having multiple managers, if one manager has a really bad year, there's just as much chance of another having a really good one," Gregory says. At Masters' Select Equity, different managers have carried the team at different times. When growth stocks were in favor in 1998 and 1999, Sig Segalas' technology picks, such as Cisco Systems (CSCO), provided the most lift, while Mason Hawkins' cheap oil stocks were a drag. Last year, they switched places. Hawkins' 1999 favorite, Pioneer Natural Resources (PXD), rose 120% while Cisco fell 29%.

Finding the best managers is Gregory's real challenge. He looks for outperformance year after year, not just a one-time blip. He also looks for low management fees: Masters' funds all charge less than 1.5%. He prefers small fund shops with few assets to behemoths like Fidelity and Putnam Investments. He wants a disciplined investment style that's consistent and readily discernible. "I don't like intuitive managers," Gregory says.

He carefully crafted the portfolio allocations at Masters' Select Equity to cover all the bases: large and small stocks, growth, and value. His job is to make sure everybody sticks to their guns. If his value managers suddenly start buying pricey biotech stocks, it throws everything off balance. To keep tabs, he meets with managers and their analyst teams as often as possible. "That's essential when running concentrated portfolios," says Bill Nygren, who runs 25% of Masters' Select Value. "If you're letting a manager's stock picks have a major impact, it's crucial to know exactly how they invest."

Gregory's newsletter and fund strategies differ. In the funds, the manager allocations are fixed: 20% Bill Miller in Select Equity; 20% Janus' Helen Young Hayes in International. But in the newsletter, he often shifts from one manager to another depending on market conditions. Recently, he has been adding junk-bond and real estate funds to his portfolios because he likes the valuations. He can't do that at Masters' Select Equity with its contractual relationship with each manager.

Gregory rarely fires a manager, but sometimes the fit isn't right. In 1998, he replaced Jean-Marie Eveillard at Masters' Select Equity with Oakmark Fund's value guy, Robert Sanborn. Eveillard, the well-regarded manager of the First Eagle SoGen Overseas Fund, didn't like Masters' concentrated style, holding more than 125 stocks in his own fund. "Eveillard was a mismatch of style," says Josh Weiss, Litman/Gregory's research director. "He's more accustomed to being a diversified manager." Nor did Sanborn work out. Poor performance drove Gregory to replace him with Bill Miller last year.

Lately, Gregory has been doing more hiring than firing. Running the Masters' funds keeps him working 65 to 70 hours a week. Litman, meanwhile, is busy managing the firm's private accounts. To ease their burden, they recently hired two fund analysts to edit the newsletter. Despite the demands on his time, Gregory still enjoys talking to a fund manager a week. "I learn so much from these guys," he says. What could be better than learning from a master? By Lewis Braham


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