Jim Cramer's Stay Mad for Life

by James J Cramer

  Heebner appears on TV once in a while. My friend Erin Burnett at CNBC likes to feature him. I turn the volume up and tell everyone in the room to shut up and listen and learn something. This is the mutual fund I would recommend to people in their 20s, along with every investor who’s still young at heart and willing to take on a bit of extra risk to produce extraordinary returns. CGM Focus is not a fund for your mother-in-law, but it’s definitely a fund for your 18-year-old. I believe that you should give your money to Heebner unless you’re getting closer to retirement or you really want an investment that will generate stable returns from year to year. In that case, you still might want to invest with Heebner, but give him only 20 percent or 30 percent of your money, splitting the rest between a more conservative value fund and a bond fund that will invest in U.S. Treasurys, or municipal bonds if you’re rich.

  2. Dreyfus Premier Strategic Value (DAGVX), run by Brian C. Ferguson. I know, I know, it’s a value fund, but it’s on the aggressive-growth list. That’s why I do not take these labels very seriously. What I do take seriously are results, and Brian Ferguson has them. Here’s another manager who has some experience making money in a down year. Ferguson’s fund was up 21.49 percent in 2000, his first year running it, and although it was down 2.5 percent in 2001 and lost bigger than the S&P 500 in 2002, a 26.81 percent decline, Ferguson made it up to his investors by gaining 43.54 percent in 2003. Since then, his fund has continued to beat the S&P 500—by 7 percentage points in 2004, 4 points in 2005, and again by 4 in 2006. That’s a record of out-performance right there, and despite the fact that Ferguson didn’t consistently make money in the down market, he came in well ahead of the pack in 2000, and that’s more than most fund managers can say for themselves. I’m much more familiar with Ken Heebner at CGM Focus than I am with most of the funds and managers on this list, because I used a rigorous, empirical method based on the data rather than relying on anecdotal evidence that I’d culled from my experience on Wall Street. The numbers and my method say that Dreyfus Premier Strategic Value is a fund that works, and Ferguson is a manager who knows how to protect you from losses. Investors of any age looking for capital appreciation will appreciate Ferguson’s results, because his fund is less risky than the other aggressive-growth funds on my list.

  3. Bridgeway Aggressive Investor (BRAGX), run by John Montgomery. Montgomery’s goal is to beat the returns you’d get from investing in the market as a whole, that is, investing in an index fund, while maintaining the same level of overall risk that you would have if you went with the index fund. In Real Money, I recommended mutual fund investors go with Will Danoff, who runs Fidelity’s Contrafund. Unfortunately, Will did the smart thing and closed off Contra to new investors, so if you’re not in it now, you won’t have the chance to join in the future. I called Contra an index fund with a brain. Bridgeway Aggressive Investor is like an index fund with a brain and an attitude. What impresses me about this fund and its manager is that in 1999, they were up 120.62 percent. That’s the kind of big win that you usually associate with a fund that is not diversified. That type of win, more often than not, is a signal that the manager doesn’t have a clue. I would expect any fund that was up 120.62 percent in 1999 to be down big in 2000, and that’s not just my spite toward and envy of Montgomery’s great year. In fact, Montgomery was up 13.58 percent in 2000, a year when the S&P fell 9.11 percent, but he was down double digits in both 2001 and 2002, although in both years he outperformed the S&P. The list of diversified mutual funds that were up in 2000, 2001, and 2002 would be a very short one, but so is the list of funds that were up in any one of those years, which is an important characteristic all by itself. Montgomery’s another manager who had a huge 2003, up 53.97 percent, more than taking care of his two years of losses. Bridgeway Aggressive Investor then beat the S&P by 2 percentage points in 2004 and 10 percentage points in 2005, and then fell behind by 8 percentage points in 2006. Over the long term, Montgomery is a winner, with an average annual return during the past five years of more than 18.13 percent, much better than the market and far better than most actively managed funds. That five-year average performance makes me like this fund for middle-aged investors who still want some risk, but with a bit more reliability.

  4. Rice Hall James Micro Cap Portfolio (RHJSX),* run by Thomas W. McDowell Jr. As you can tell from the name of the fund, McDowell invests in micro-cap stocks, which are stocks with a market cap of anywhere from $50 million to $500 million. If you remember, market cap, short for market capitalization, is one widely used way to value a company. You take the price per share and multiply it by the number of shares to come up with a figure that’s a good proxy for how much money the market thinks the company is worth. Investing in micro-cap stocks is a pretty risky proposition, which is why I asterisked this fund. Even though it meets the standards I set down in my methodology for picking funds with great managers, the fact that it’s all micro-cap stocks makes me slightly uneasy. Companies this small can make you a lot of money, but as you can imagine they’re more risky than larger companies. I think this would be a terrific fund if you wanted to use a part of the money that you intended to invest in stocks to speculate instead in mutual funds. Granted, McDowell’s performance is reassuring, but I have to accept the conventional wisdom and say this is a fund that invests in some pretty high-risk stocks. There’s a place for that in every portfolio, but it shouldn’t be your entire portfolio. Still, looking at the numbers, I see a manager with a strong record. McDowell made money in both 2000 and 2001, up 11.24 percent and 16.41 percent, respectively. He lost big in 2002, but still beat the S&P by a little less than a point. Again, what’s unusual is the outperformance in 2000 and 2001. I would have liked to see better numbers in 2002, but for an aggressive-growth fund that invests in high-risk stocks during a bear market, it’s almost surprising that McDowell didn’t do much worse than the S&P in 2002. At any rate, like everyone else on this list so far, McDowell had a grand-slam 2003, when he was up 56.62 percent. He continued to outperform in 2004 and 2005, but came in 2 percentage points behind the S&P in 2006.

  Because this fund invests only in micro-cap stocks, it might make more sense to compare it to a different benchmark, the Russell 2000, which consists of 2,000 stocks with market capitalizations that skew slightly larger than McDowell’s micro-cap investments. The Russell 2000 looks much more like McDowell’s portfolio than does the S&P 500, which is made up of large-cap stocks. At any rate, the Russell 2000’s average annual return over the past five years was only about 16 percent, while McDowell averaged 18 percent. Even taking into account this fund’s expense ratio of 1.19 percent, McDowell still beat the Russell 2000.

  This is another fund that you definitely don’t want to give to your mother-in-law, and even if you’re giving it to a kid who rides a motorcycle and sky dives, a real risk-taker, it shouldn’t be more than 30 percent of total assets, because micro-cap stocks are just too risky.

  5. Legg Mason Partners Aggressive Growth (SHRAX), run by Richie Freeman. I highlighted Freeman in Real Money as a stock-picker’s stock-picker, a man who lives and breathes stocks, someone who cannot stand to fall behind the benchmarks. In Real Money, my mutual fund analysis was based as much on my firsthand knowledge of the fund managers as it was on the numbers. I think both perspectives are invaluable, especially because so few people have the knowledge to express either one. But my current endorsement is based on Freeman’s record, on the data, and not on my personal knowledge of the guy. Still, Freeman is another manager who made money in 2000, a lot of money actually; he was up 19.12 percent. He was down in 2001, and then down 32.75 percent, worse than the S&P 500, in 2002. Because the man is so driven it looks like he’s been trying to make up for it ever since—up 36.57 percent in 2003, up 10.61 percent in 2004 (a hair’s breadth behind the S&P), up 12.55 percent in 2005, 8 percentage points better than the benchmark. Then last year Freeman gained only 7.98 percent, compared to over 15 percent for the S&P. I’ve written before that I like to bet with Richie
after he’s had a worse year than the benchmark, because he’s such a competitive guy. You’ve got another chance to take advantage of his nature, and his ability to make money when others lose. Richie Freeman is a fund manager for all ages; whether you’re in your 20s, 30s, 40s, or 50s, his tenacity will serve you well.

  Growth Funds

  Before discussing the two growth funds on my list, I should say a little more about the methodology I used to generate these mutual fund rankings. This method originally produced five growth funds and ten value funds, but three of the growth funds and five of the value funds were closed to new investments. This isn’t great in terms of your options, but it does help validate my analysis. Only the best funds that attract the greatest money have to close themselves down to new investors. The fact that my methodology picked out eight growth and value funds that had been closed and only seven that were still open makes me believe that looking at the off-years, the years when the market is down, and selecting funds that were up (or down less than the market) in spite of the market’s weakness, is the right way to go when hunting for a good mutual fund.

  1. Buffalo Small Cap (BUFSX), run by Kent Gasaway. Buffalo is a growth fund that invests entirely in small-cap stocks. Gasaway’s annual turnover is only 15 percent, compared to 116.18 percent for other growth funds. The turnover is the amount of buying and selling that your fund manager does in a year: a fund with a 100 percent turnover replaces all of its holdings once in a given year. When your fund manager sells stock at a gain, your fund pays capital gains tax, so if a fund is good, a higher turnover will really eat into your return. Gasaway’s low turnover suggests that he’s a longer-term investor who has real conviction in his stock picks, which I think many of you can appreciate. For those who would be more attracted to a sizzling hot fund run by a more aggressive trader, allow me to show you Gasaway’s magnificent returns. Remember, the entire reason to invest in an actively managed fund is so that the manager can sidestep losses that the market takes. You’re not paying for additional upside; you’re paying to avoid the downside that comes with stocks. If you want both the additional upside and the protection from downside, Kent Gasaway is your man. His performance during 2000 and 2001 was tremendous. He gained 33.69 percent in 2000 and 31.18 percent in 2001. He mopped the floor with the benchmarks. In 2002, he lost 25.75 percent, but he made up for that with a 51.23 percent gain in 2003. He followed that up with a 28.82 percent gain in 2004. In 2005 and 2006, Gasaway lagged the S&P by a little more than a point each year. The recent underperformance is not encouraging, but you’re still looking at a fund manager who’s got a five-year average annual return of 18.86 percent and a fund that’s been down only one year of its eight-year existence. I will take Gasaway’s recent slight underperformance in a heartbeat if it means he’ll continue to deliver stellar performance in the years when the market is down big.

  There is one big point here that you should keep in mind. Since Gasaway’s fund invests only in small-cap stocks, you probably don’t want his fund to be the only stock fund you own. There are years when small-cap stocks do better on average, and there are years when large-caps stocks do better on average, although I believe there are more gains to be had among small-cap names. Nevertheless, you probably don’t want all of your stock exposure in a fund that focuses solely on little companies. I wouldn’t call Gasaway’s fund speculative, but it’s so concentrated in small caps that in the interest of diversification, you might want to put the same amount of money in a fund with more large-cap and mid-cap exposure. That would be the prudent and correct course, even though Gasaway’s got a clear ability to win when others lose.

  2. FBR Small Cap (FBRVX), run by Charles T. Akre Jr. This is another small-cap growth fund, that, just like Buffalo Small Cap, is characterized by fairly low turnover, meaning the fund buys and sells stocks far less frequently than the average growth fund, which, among other things, saves you money. When you see a fund with great performance and low turnover, you’re looking at a fund run by a terrific investor, not a trader. I have nothing against trading—in fact it was one of the things I did best at my hedge fund—but I know many people have a built-in bias against trading that they will never overcome. This fund manager and his fund cater to you. Akre is a long-term thinker with a great track record of picking out small-cap stocks, those with market capitalizations of less than $3 billion, with great long-term growth stories. Akre’s the kind of manger who seems to be terrific at finding long-term winners and riding them all the way up.

  Akre’s fund lost 8.79 percent in 2000, but then came back with a really landmark year in 2001, gaining 32.63 percent in a year when the S&P 500 was down double digits. That’s the kind of thing that really turns fellow money managers green with envy. Luckily, you can turn green with dollars by giving Akre your money so that he can invest it in his FBR Small Cap fund. Akre’s fund gained only 2.63 percent in 2002, but that was astonishing in a year when the S&P lost over 22 percent. And then the numbers just kept getting better. He posted a 45.77 percent gain in 2003 and a 30.67 percent gain in 2004. He had a paltry 2.31 percent gain in 2005, more than 2 percentage points beneath the S&P’s return, but made up for that and then some by his 28.49 percent gain in 2006. Growth funds tend to be less risky than aggressive-growth funds, but I’m not convinced the evidence bears that out. What I do know is that Charles Akre’s fund looks unstoppable.

  This fund is for longer-term mutual fund investors, no question. But if you have the patience to stick with this guy through the lean years—it looks as though every third year or every other year is a dud, with gains in the low single digits or even small losses—he’ll deliver the big long-term results. The reward of staying in this fund through the lean years is that they’re followed almost inevitably by some really fat years, where the gains range from 28 percent to 45 percent, more than making up for the slow times. Akre’s fund is a great place for more conservative investors who still want some exposure to growth. If you get along well with your mother-in-law, this would be a good place for her to invest. Akre is a manager for people who really want long-term outperformance and care less about year-to-year wins. So if you’re a more conservative investor, or you’re in your 30s and 40s and still have a long time before you retire, this fund is for you. There’s a place for FBR Small Cap in anyone’s retirement fund, but because it is a small-cap fund, it shouldn’t be your whole retirement fund. Unfortunately, because 401(k) plans don’t let you choose your own funds, you probably won’t have the opportunity to invest with Akre in your 401(k). Instead, invest in his fund with the money in your IRA. Whether you’re 25 or 55, this is a great retirement mutual fund.

  Value Funds

  1. Putnam Small Cap Value (PSLAX), run by Edward T. Shadek Jr. Shadek worked for one year, 1992, at Steinhardt Partners, led by Michael Steinhardt, who was one of the first legitimately famous hedge fund managers. Steinhardt has a phenomenal record in addition to being a really great guy. When I started my hedge fund, he actually let me operate out of his office until I got my feet on the ground. He also got Will Danoff his start and Fidelity’s Contra fund has benefited ever since. At any rate, Shadek worked for the best, and now he’s performing like a true disciple of Steinhardt’s. I should point out that Putnam Small Cap Value is another fund that invests mostly in stocks with low market capitalization, and that means you should at least consider investing in another mutual fund on top of Shadek’s to spread your exposure to different kinds of stock. Then again, when you look at this guy’s record you might not want to. Shadek was up 24.43 percent in 2000. He was up again, this time by 18.95 percent in 2001. His fund did lose 18.69 percent in 2002, but that performance was better than the market.

  As far as I’m concerned, any mutual fund manager who was up in 2000 and 2001 deserves some slack for taking the hit in 2002. It’s not ideal, but considering that the vast majority of funds were down all three years (and did not beat any benchmarks at all unless they were competing for the biggest losses), Shadek’s record
starts to look quite impressive. He came back with a 50.67 percent gain in 2003, followed by a 25.67 percent gain in 2004, then a 6.78 percent gain in 2005, and a 17.30 percent gain in 2006. This guy has been one step ahead of the market all along. A fund with a manager who can make you money when other funds can’t stop losing, and who can remain ahead of the market in good times, is a fund I want to be in. Sure, you could say that Shadek’s fund barely outpaced the Russell 2000 over the past five years and delivered a substantially lower return after fees, but I have to point out that investing in an index fund pegged to the Russell 2000 would not have given you double-digit gains in 2000 and 2001. People really don’t understand that fund managers are paid to take care of the downside. Once you’ve got someone good worrying about how to prevent you from losing money, you can let the upside take care of itself.

  Shadek’s fund isn’t cheap. Most mutual funds have two or three classes of shares, with different fee structures, although one class is usually for giant institutional investors. If you want to invest in the Putnam Small Cap Value fund, you can take the A-class fund, which has a 1.27 percent expense ratio, no more than .25 percent in 12b-1 fees, and a 5.25 percent front load. I know sacrificing 5.25 percent of your investment for long-term gains is obscene, but in fact this is the cheaper, more sensible option. If you buy into the C-class fund, you’ll have a 2.02 percent expense ratio and pay 1 percent a year in 12b-1 fees, making your annual fees almost double what you’d pay in the A-class fund. There’s no front load in C-class, but there is a deferred sales load, a back load, of 1 percent, which you have to pay when you sell. I would take the 5.25 percent hit up front to invest here, as it’s certainly worth it for the downside protection, rather than giving up 3 percent of my assets in the fund every year to management. As with all small-cap funds, this one can’t be your only exposure to stocks, but I would recommend it for older investors in their 40s and 50s who are nearing retirement.