Five questions to ask when a fund changes managers
IT’S the news every mutual fund investor dreads: Your star portfolio manager, who has made you a boatload of money over the years, is leaving to start a hedge fund.
And he isn’t taking you with him.
It happened to me with a stock fund I had owned since 1983. Under manager Ross Margolies, the Salomon Bros. Capital fund posted gains averaging 18% a year for about a decade.
Then about three years ago, Margolies left to launch his own hedge fund for people far better-heeled than me.
Like many buy-and-hold individual investors facing a fund shake-up, I stayed put. Inertia is a strong force. Plus, hope springs eternal that a new manager could bring his or her own brand of magic to the portfolio.
As it turned out, Margolies’ successor, Kevin Caliendo, did a great job in 2004 and 2005. The fund’s performance was above average. I felt brilliant for doing nothing.
But then the helm changed captains again. The fund, renamed Legg Mason Partners Capital, was handed to a new manager last summer. He has completely remade the portfolio. And I and my fellow shareholders have been left to decide once more: Do we stay or do we go?
Veteran mutual fund investors often learn the hard way that funds, like individual stocks, can enjoy long periods of success -- and then fade into mediocrity, or worse.
Just look at what happened with Fidelity Magellan, once the flagship of that fund empire. It has lagged the benchmark Standard & Poor’s 500 index in five of the last seven years.
As an aging baby boomer (I turned 50 last year), I’ve become more sensitized to the risk of holding on to laggard mutual funds. The retirement clock is ticking. It will make a big difference to me if one of my funds earns 8% a year over the next decade as opposed to, say, 6% a year.
So what do I do with the Legg Mason Partners Capital fund? The new lead manager, Brian Posner, has been on the job for about nine months, with mixed results. I can’t predict how he’s going to perform in the long run, but I can pose some basic questions about the changeover in trying to decide what my comfort level is with staying.
Here are five issues I considered in light of the regime change. If you find yourself in a similar situation with a new fund manager, these questions might be useful to you as well.
* Has the fund’s investment philosophy changed? If a fund has been a dismal performer, you might well want it to change tack under a new manager. In the case of the Partners Capital fund, what attracted me to the portfolio in the first place was its eclectic approach: the manager’s ability to buy stocks of any size, in any industry, rather than be a slave to those so-called style boxes (“large-cap growth,” “small-cap value,” etc.).
In reports to shareholders since Posner came aboard last year, the fund has pledged to retain that go-anywhere investing style. Posner also says he plans to maintain the relatively focused nature of the portfolio. Some funds own hundreds of stocks. Posner plans to keep the number around 50.
That means the $1.5-billion fund has greater potential than more diversified funds to score big with its hits -- and also greater potential to lose big on ideas that go bad. I’m comfortable with that, given that this is just one piece of my total portfolio.
* What does the new manager bring to the table? This can be a tough question for a fund shareholder to research because fund companies often tell you relatively little about their managers. Morningstar Inc., the investment research firm, is a good objective source.
Posner, 45, is no fund newbie. He began his career as an analyst at Fidelity Investments in the late 1980s, studying under legendary stock picker Peter Lynch, who at that time managed the Magellan fund. Posner ran Fidelity’s Equity Income II fund from 1992 to 1996, during which he beat the average fund in his peer group. He moved to the Warburg Pincus fund group in 1997, then ran his own hedge fund from 2000 to 2005.
So there’s an interesting twist here: Posner left the hedge fund business to return to mutual funds. No doubt Legg Mason Inc. made it worth his while, financially. Which also makes me expect more from him, in terms of performance, than I might expect from another manager.
* Do you like what’s in the portfolio? If you own an actively managed mutual fund, you ought to have some idea of what’s in the portfolio. The fund tells you at least twice a year. You certainly should want to know what a new manager is doing with your money.
In a recent interview I did with him, the New York-based Posner described himself as fundamentally a “value”-oriented stock picker. But value always is in the eye of the beholder. Posner says he looks at a stock’s price relative to the long-term cash flow he thinks the company can generate.
In the second half of last year, he substantially reshuffled the portfolio. It’s practically a new fund. Gone are healthcare issues such as Amgen Inc. and Abbott Laboratories Inc., mining firm Barrick Gold Corp. and classic old growth stocks such as Altria Group Inc., parent of the Philip Morris tobacco company.
What he found in the second half of last year, Posner said, was that the stocks that looked cheapest relative to the companies’ cash flow included issues such as computer networker Cisco Systems Inc. and financial services giants JPMorgan Chase & Co. and Lehman Bros. Holdings Inc.
In the six months ended Dec. 31, the fund gained 13.9% in my share class, beating most major market indexes. Posner was off to a good start.
In the first quarter, however, the fund lost 0.1%, compared with a 2.1% gain for the average U.S. stock fund, according to Morningstar. Posner’s heavy bet on financial stocks bit him, and me, in the period. But I think he’s right about the value in those names, so I’m not worried.
* Is the fund manager’s own money in the portfolio? Posner says he put the bulk of his free investment capital into the fund before he took over the portfolio in July. So I feel that his interests are aligned with mine.
“I firmly believe, if you’re running a diversified portfolio and that portfolio is not your primary means of investment, I don’t know how you can go out and recommend that people buy it,” he said.
Unfortunately, it isn’t easy to find out whether your fund manager eats his own cooking. That information typically is buried in something called the “statement of additional information” that’s available on the fund company’s website. And the fund is required to disclose only a dollar range of ownership.
* What other responsibilities does the manager have, besides running my fund? This is where I get worried about Posner. Legg Mason hired him primarily to be chief executive of ClearBridge Advisors, one of the firm’s fund management units. He oversees a staff of about 190 people, including 23 portfolio managers.
I think it’s admirable that he also wanted to keep his hand in directly managing money, via my fund. But will he really have the time to properly manage both my fund and the company?
Posner insists he can do both, with the help of his co-manager, Brian Angerame. But I have to admit, his wearing two hats makes me nervous.
I asked him how long he thought shareholders should give him to show that his performance was worth the management fees we’re paying.
Posner said he’d like two to three years to prove his mettle. But he acknowledged that it was more realistic to think that many investors would give him one to two years.
That sounds fair to me.
*
(BEGIN TEXT OF INFOBOX)
Fund profile
Name: Legg Mason Partners Capital
Assets: $1.5 billion
Investment strategy: Seeks capital appreciation by investing in stocks of U.S. companies of any size. Also can buy foreign issues and fixed-income securities.
Major stock holdings (as of Dec. 31): Marsh & McLennan Cos., American Express Co., Motorola Inc., JPMorgan Chase & Co., Cisco Systems Inc., Lehman Bros. Holdings Inc., Capital One Financial Corp., WPP Group
Major stock holdings by industry sector (as of Dec. 31): Financial services (28.8% of the fund), technology (27.1%), industrials (13.1%)
2006 performance: A total return of 11%, lagging behind the 12.6% gain of the average U.S. stock fund
First-quarter 2007 performance: Down 0.1%, lagging behind the 2.1% gain of the average U.S. stock fund
What Morningstar Inc. says: “Flexible mandate gives managers freedom to choose whatever seems most appealing, without following peers or indexes.” Annual fund management fees are “reasonable” at 1.1% of assets for Class A shares. But the new lead manager, Brian Posner, also is CEO of the investment management parent, which raises concerns about constraints on his time.
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Sources: Times research, Legg Mason Inc., Morningstar Inc.
