Commentary: The Importance Of Independent Thinkers

Ron Baron, James Gipson, Bill Miller, and Robert Torray are mutual fund managers who stand apart from the crowd. While the average equity fund might have 80 to 100 stocks, these have 20 to 30 companies and thus, much larger stakes. They're patient investors, too, amassing their positions over time.

Through the years, such managers have racked up winning records. In one study, fund researcher Morningstar found that more than 80% of concentrated funds beat their more diversified peers in six of the seven domestic equity fund categories. That study measured rolling five-year returns from 1992 through 2003.

While funds run by independent thinkers like Legg Mason's Bill Miller belong in most portfolios, they have downsides. Though multi-year returns are great, any one year may not be -- and 2004 is one of them. One problem with this style of investing is that it tilts toward companies that are out of favor and mostly shunned by Wall Street. Sometimes it takes longer than expected for one-time basket cases to become stars, or they continue to go down before they go up. "You can't worry about being down a few percent," says Gipson, long-time manager of the Clipper Fund. "You do your homework and concentrate on your best ideas."

The other problem with concentrated investing is when a stock sours, it can do some serious damage. For instance, Baron's firm collectively lost $566 million in two large stakes from December, 1995, through October, 2004: the art auction house Sotheby's Holdings (BID) and AMF Bowling Worldwide.

To avoid that again, Baron is dialing back on concentration. Now, five of his six funds can't have more than 10% of assets in any one stock. In addition, his six funds together can't own more than 10% of a single stock. "This won't eliminate losses," says Baron. "But when we make a mistake, we don't want to lose as much."

Baron shareholders will not likely complain about these changes, since this year's returns range from 10% to nearly 37%. But such limits could cap the potential gains you can get from letting the winners run. Mutual-fund investors will lose out if focused managers start getting mypoic about results and damp their concentrated strategies.

If people could invest in only one fund, a concentrated fund would be risky. But no one owns just one fund anymore. Using index funds, investors can gain plenty of diversification at a low cost. What they do need in their portfolios is the unconventional wisdom that these stockpickers have to offer.

By Christopher Farrell

Cash Is for Losers
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