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If picking stocks is a random walk down Wall Street, as Princeton economist Burton Malkiel famously put it, then picking mutual funds is an obstacle course through Hell's Kitchen. True, by focusing on low-cost funds and those small enough to trade stocks nimbly, you can tilt the odds in your favor. Yet even the smartest, most determined fund-picker can't escape a host of nasty surprises.
The latest evidence of just how tricky it is to pick the right funds comes from a smart, determined guy named Ken Gregory. A veteran investment adviser and publisher of the No-Load Fund Analyst newsletter, Gregory jumped out of bed one night in 1994 with an idea for a fund of his own. "I did a brain dump into the PC," he recalls. Next morning, Gregory awoke with a plan for what today is Masters' Select Funds. Each fund, he imagined, would split its cash among a diverse handful of the best pros--"masters"--that he could find. Yet unlike earlier "funds of funds," each manager would be allowed to pick no more than 15 stocks at a time--their absolute best investment ideas.
Masters' Select Equity opened in December, 1996. If only because innovation in the fund industry usually means starting, say, a telecom fund just as that sector tops out, Gregory's idea was refreshing. Five years later, with benchmark-beating records, it is proving its value (table). "The question with any fund is, `Are you getting good risk-adjusted performance?"' Russ Kinnel, Morningstar's top fund maven, told me. "These funds have delivered."
Just the same, it has been no cakewalk. Which is why Gregory's experience is worth reviewing. He and his five analysts devote themselves to evaluating managers: putting them through written questionnaires, phone interviews, in-person visits, and portfolio analyses. They debate it all. They do way more, in other words, than you or I could hope to do. Still, Gregory has faced four crises staying on course.
First, Gregory found he had made a mistake in tapping Jean-Marie Eveillard. Eveillard runs First Eagle SoGen Global with scores of stocks and could not get comfortable picking just 15. "Running a concentrated portfolio was not really my cup of tea," Eveillard told me. So, in 1998, Gregory swapped him for Oakmark Fund's Robert Sanborn. Trouble was that Sanborn, who was under pressure as his style of value investing suffered a deep downturn, quit Oakmark a year and a half later. So Gregory replaced Sanborn with Bill Miller of Legg Mason Value.PARTING WAYS. In 1997, Gregory opened another fund, the Masters' Select International. One of its five managers, Bruce Bee, died unexpectedly in 1999. Replacing him took some quick work. Just as unexpected was the puzzling trouble with Helen Young Hayes. Star manager of Janus Overseas and Worldwide funds, Hayes also ran 20% of Gregory's international fund. He said he began a year ago to suspect that she was not focusing on it. Hayes reassured him, and in the fund's annual report he wrote: "We have an extremely high degree of confidence with respect to all of our managers." The report even singled out Hayes for a Q&A.
But by last summer, Hayes seemed to Gregory to pay even less attention to his fund. Gregory approached Hayes, and after some discussion the two agreed she was unable to maintain the same commitment that they both expected when she joined the fund. Hayes left Masters on Sept. 30. She isn't talking, but a Janus spokeswoman said: "This was a mutual decision that was in the best interests of both parties. We have parted ways amicably."
It's true, as Gregory told me, that most of the managers he picked for the Masters' funds have worked out fine. Yet his experience also tells me that even when you know what you're doing, and even when you do it full time, picking a fund manager is devilishly hard. Next time you're tempted to buy anything other than an index fund, remember this--and think again. By Robert Barker