Trying to capture some of the more than $3 trillion in cash sitting in client accounts, advisers are looking outside the style box to identify those undiscovered funds that have the potential to be tomorrow's gems.
They are turning away from famous funds and star managers at large asset management companies in favor of less-known offerings with shorter track records or fewer assets.
One sign of a potential winner is a seasoned manager with the freedom to follow his or her own investment style and cast a wide net for opportunities, including shifting to the safety of cash when it appears that the markets are turning sour.
By contrast, some of the larger fund managers are more focused on asset gathering than performing for investors, according to these advisers.
“In general, the small guys are focused on making money for clients rather than building an empire,” said Russel Kinnel, head of mutual fund research at Morningstar Inc.
Take, for example, the Marketfield Fund (MFLDX). Vern Hayden, president of Hayden Financial Group LLC, which manages $110 million in assets, said that his firm has many little-known funds in its client portfolios and likes this go-anywhere fund, managed by Michael Aronstein, because it uses a variety of investing strategies, including short sales.
Likewise, Manning & Napier World Opportunity Series (EXWAX) flies below the radar but has consistent performance and a stable management team, Mr. Kinnel said.
One way to find promising funds and advisory shops, advisers said, is to be on the lookout for managers and products that are in transition or being reorganized.
For example, Cecilia Gondor, executive vice president at Thomas J. Herzfeld Advisors Inc., which manages about $100 million in closed-end funds, likes the DCA Total Return Fund (DCA) and the DCW Total Return Fund (DCW). Both funds were previously income-oriented closed-end funds but have been revamped into total-return portfolios subadvised by Calamos Investments (the RIA unit of Calamos Holdings LLC).
Doug Flynn, co-founder of Flynn Zito Capital Management LLC, which has $250 million under management, said he quizzes wholesalers for unknown or low-ranked funds that may be undergoing manager changes.
An up-and-coming fund with a new manager might have a horrendous 10-year rating, he said, which brings down its overall score from Morningstar.
The trick is training wholesalers to be contrarian, Mr. Flynn said. “It's easy for wholesalers and most advisers to just throw five stars at people,” he said.
For smaller fund groups that may not have wholesalers, “it's surprising how commonly we can get the portfolio manager on the phone,” Mr. Flynn said. “You can get information that isn't going to show up on a Morningstar report.”
Smaller funds also don't have to deal with the size problem, Mr. Hayden said. “There's not a bunch of money coming in and piling up, and little pressure [on a manager] to invest money he doesn't want to,” he said.
Managers of undiscovered funds also tend to stay at the helm for long periods and maintain a low profile. “A lot of these fantastic [mutual fund] managers just don't do any marketing, because the bulk of their business is institutional,” said Adam Bold, chief executive of The Mutual Fund Store LLC, whose advisers manage $4.8 billion in client assets.
For example, the Thomas White International Fund (TWWDX) has consistently outperformed its benchmark index, Mr. Bold said. Even so, “nobody knows about it,” he said.
And since a lot of new mutual funds were launched in the late 1990s or later, they haven't built up an attention-grabbing track record, because of successive bear markets, Mr. Kinnel said. That's particularly true of large-cap-equity managers, he said.
Advisers should also watch for manager spinoffs from larger advisory firms, said Matt Cooper, managing director at Beacon Pointe Advisors, a wealth management firm with $4 billion in assets that specializes in finding unknown managers.
Mr. Cooper said his firm will use these spun-off advisers once they have a five-year track record and $100 million under management. “We especially look at three-year rolling periods, and [a manager's] up and down capture,” he said.
Word of mouth among colleagues, clients and other professionals also turns up unique ideas, advisers said.
“I don't have a real scientific way to do it,” Mr. Hayden said. “I check the Internet a lot, read publications and keep my eye out for new names.”
E-mail Dan Jamieson at [email protected].
