Q&A: CRAIG LITMAN "DO I EAT MY COOKING? ABSOLUTELY"

Craig Litman was a mutual fund junkie before they blanketed Main Street. In fact, Mr. Litman and partner Ken Gregory started marketing the No Load Fund Analyst newsletter in the early days of their money management firm a decade ago because they were “struggling and looking for ways to make money.”

Though fund performance was dissected in those days, Litman/Gregory’s specialty — the analysis of fund managers’ investment style — was rare.

Larkspur, Calif.-based Litman/Gregory, which manages $500 million, took its expertise to the limit early last year by sponsoring the Masters’ Select Equity Fund, which is run by six nationally known managers: Shelby Davis of Davis New York Venture, Jean-Marie Eveillard of SoGen International, Foster Friess of Brandywine Fund, Mason Hawkins of Longleaf Partners, Spiros Segalas of Harbor Capital Appreciation and Richard Weiss of Strong Common Stock Fund.

Six weeks after Asian economic concerns sent jitters through the market in late October, Litman/Gregory launched an international version of the Masters’ Select fund with a new set of top managers — five, this time.

Mr. Litman says he and Mr. Gregory are mulling what sector the next Masters’ Fund should tackle. But the managers will have to wait at least a year to get their next assignment.

Q: Was it easier to get in touch with portfolio managers when you started out following mutual funds?

A: It was clearly easier to talk to them for a couple of reasons. There weren’t nearly as many people interested in funds or advisers in funds, and the media attention wasn’t that great so they weren’t getting called that often. Now, I think it’s really tough for them.

Q: If they won’t talk to you, does it color the way you feel about them?

A: It depends on why we can’t talk to them. By and large, we’re able to talk to most. Frankly, we prefer that they don’t spend all the time taking calls that they probably could. We respect their time and the managers that we talk to, I think, know that. So we can usually get access to just about anyone. By the same token, there are a lot of advisers now investing in funds and a lot of people want to talk to managers. That poses a real conflict for them in terms of where should their time be spent.

Q: Describe the strategy for your Masters’ Select funds.

A: We were searching for ways to access some of these great managers that we knew, but hopefully in a way that the funds weren’t going to get too big, that they weren’t going to get discovered way too fast and have assets balloon, which would affect their performance.

It seemed to make sense to us that a good manager was going to have a better chance with his five or 10 best ideas than he’s going to have with his 50th and 60th ideas.

Tied into that was the condition that in order to do that, we’d have to limit the amount of assets they would have. Managers’ stakes are capped at between 10% and 20% in the domestic fund and between 10% and 22.5% in the international fund.

When assets reach between $500 million and $750 million for the domestic fund and $1 billion for the international, the funds will close to new investors.

Q: What are some common characteristics of your favorite managers?

A: They have long track records. They’re all managers who really exhibit a passion for what they do almost to the point of being obsessive. They’re either owners of their firms or have significant positions, so they’re not likely to go anywhere. In most cases, they have significant assets of their own invested in their firms and in their style.

Q: Do you think it’s a good idea for investment advisers to run their own funds?

A: If that’s what they do best, they should follow their hearts and do that. There are others who don’t belong in that business, for a variety of reasons. With somewhere in the neighborhood of 8,000 mutual funds now, it’s pretty easy to narrow that down to a couple of hundred that are really worth following — that tells you quite a bit about many of the rest.

Q: If we see a market correction, what’s going to happen to the 7,800 or so funds you say aren’t worth pursuing?

A: A number of small funds won’t grow in that environment. We also will see investors who have ridden the bull market and will sell off when a downturn hits. Those investors may not return to the fund universe or stock market for a long time.

Q: What trends do you see in the mutual fund industry today?

A: Investors are becoming more sophisticated and are beginning to demand more things from their fund managers. The latest is tax efficiency. More managers are going to have to deal with that. But I don’t think it should be a paramount concern for investors. They should focus on performance and total return.

Q: Do you follow your own investment advice?

A: Do I eat my cooking? Absolutely. Since we launched the mutual funds, I’ve been putting my money in. I have a lot of confidence in the managers and what they’re doing for us.

VITE

Craig Litman, 51, chief executive officer, Litman/Gregory & Co. Inc. LLC and Litman/Gregory Fund Advisors LLC, Larkspur, Calif.

Assets: $425 million; $75 million non-discretionary. Minimum client size: $1 million

Masters’ Select Equity Fund (assets $400 million): year-to-date, 16.81%; 1-year, 47.7%

Wilshire Large-Cap Growth Index: year-to-date, 17.18%; 1-year, 41.17%

Assets as of April 30.

Source: Morningstar Inc. and Litman/Gregory & Co. Inc.