It's a new year and that means award season here at Morningstar. Each year since 1987, we have crowned a new Fund Manager of the Year. Since then, the award has expanded to five categories. We kick things off by announcing our nominees for Morningstar's Domestic-Stock Fund Manager of the Year. Tuesday's Fund Spy will unveil our International-Stock Fund Manager of the Year nominees, with the Fixed-Income, Allocation, and Alternatives nominees to follow. The winners will be announced live on CNBC on Jan. 15.
Even though the Fund Manager of the Year award is based largely on what a manager accomplished in 2013, it's also a lifetime achievement--or tenure achievement--award. Our goal is to recognize long-term success rather than a comet blazing across the sky. With this in mind, we often look for cases where a manager has succeeded despite headwinds, as opposed to someone who's simply benefiting from market momentum. With the S&P 500 Index up nearly 32% in 2013, we had to be especially mindful of this, as there wasn't much--outside of gold miners--that didn't work.
In alphabetical order by fund name, the nominees are:
William Martindale and Robert Mitchell, Conestoga Small Cap (CCASX)
2013 Return: 49.26%
Morningstar Category Rank (Percentile): 9
There was certainly plenty of positive momentum within Conestoga Small Cap's growth realm. In 2013, the small-cap stocks that tended to do best were more speculative in nature, with lower margins and higher levels of debt. Such characteristics run counter to managers William Martindale and Robert Mitchell's preference for high-quality companies. Such standards should have worked against the fund in 2013, which makes its results all the more impressive and speaks to the duo's excellent stock-picking.
Historically, the fund's high-quality holdings have tempered volatility and have helped it typically outperform in down markets. The managers invest with conviction and for the long term. They tend to hang on to their picks for three to four years. Two top-five holdings bought in early 2008, CoStar (CSGP) and Tyler Technologies (TYL), both doubled last year, helping to fuel 2013's excellent results.
Note that Martindale plans to retire in the summer of 2014. Mitchell remains on board and will be joined by Joe Monahan, who joined the firm in 2008 and is a manager on sibling Conestoga Mid Cap (CCMGX).
Dodge & Cox Investment Policy Committee, Dodge & Cox Stock (DODGX)
2013 return: 40.55%
Morningstar Category Rank (Percentile): 2
Dodge & Cox Stock is on track for its second-consecutive top-decile showing in the large-value category. After poor results during the financial crisis, this team has largely redeemed itself. A number of longtime holdings, some of them contrarian plays, paid off this year. Hewlett-Packard (HPQ) is the most notable example; Softbank's investment in Sprint (S) was another vindication. (Dell and J.C. Penney (JCP) are recent exceptions, but these were also very small positions that did not do much damage.) Overall, the managers added significant value with their tech picks, as Microsoft (MSFT) was another major contributor. The fund's large stake in financials was another advantage, with Schwab (SCHW) its leading pick.
Despite occasional hiccups, Dodge & Cox practices thoughtful, deliberate value investing, and this fund benefits from one of the deepest, most consistent investment teams in the business. Shareholders willing to ride out the bouts of underperformance that come with contrarian stock-picking have been rewarded over the long term.
Dennis Lynch and Team, Morgan Stanley Institutional Growth (MSEQX)
2013 Return: 48.60%
Morningstar Category Rank (Percentile): 1
While it's true that growth manager Dennis Lynch and his team have had the wind at their backs during the past year, the degree of their funds' outperformance suggests that they didn't simply benefit from a rising tide in 2013. The team looks for companies with defensible business models that earn high returns on capital and generate significant cash flow. These companies often dominate their niche markets or benefit from a strong network effect. Spin-offs and the leftover "stub" companies frequently pique Lynch's interest, as he finds that they often have few comparable competitors and are misunderstood by the markets.
Lynch further differentiates his funds by making investments in privately held companies, many of which are sourced through the team's contact network. Investments have included a notable stake in social networking firm Facebook (FB) more than a year before it went public. He also invested in Twitter (TWTR) three years prior to its November 2013 IPO, with the shares having since tripled. However, some of Lynch's funds also had small stakes in Better Place, which built infrastructure to support electric vehicles. That firm declared bankruptcy in early 2013, illustrating one of the pitfalls of investing in such early-stage companies.
The team is sector agnostic when building the funds' portfolios, so it's not unusual for their performance to be out of step with their indexes or more benchmark-oriented peers. A steady above-average allocation to foreign stocks also exacerbates the unpredictability of performance. Overall, the team's high-conviction process and long investing horizon have resulted in periods of high volatility. This fund is only for investors with similarly long time horizons.
Harry Burn, Gibbs Kane, John DeGulis, Sound Shore (SSHFX)
2013 Return: 41.53%
Morningstar Category Rank (Percentile): 2
This fund generally warms to high-quality companies that are experiencing temporary problems. The management team's patience, though, arguably led to the fund's best relative and absolute results in years. For example, Hospira (HSP) caught the team's attention after the health-care firm curtailed production at one of its plants owing to FDA concerns. Its share price fell by about half in late 2011. But Harry Burn, Gibbs Kane, and John DeGulis didn't buy immediately, as they often do.
Instead the managers waited to see signs of improvement. Even though waiting could have meant missing out on some of the rebound, they preferred to see solid evidence to support their optimism, such as rising production rates at the plant in question. They eventually bought in 2013's first quarter and the stock has jumped more than 25% since then. They also waited before buying formerly embattled insurer American International Group (AIG), holding out until the U.S. government was about to finally relinquish control. They bought in 2012's third quarter, and though they missed out on earlier gains, they still have enjoyed a nice ride with the shares up about 45% in 2013.
The team's patience isn't always obvious. The three managers often hold stocks for years, although this doesn't necessarily show in the fund's turnover ratio. Many stocks appear to have been bought in the past couple of years, but in many cases, these are companies they've sold over the years on valuation and then bought back. Since the fund isn't afraid to buy troubled companies, some in its portfolio could stay troubled for a while, or never work out. This was partly the case in 2011, when the fund lost 8 percentage points more than the S&P 500 and landed in the category's 86th percentile.
Larry Puglia, T. Rowe Price Blue Chip Growth (TRBCX)
2013 Return: 41.57%
Morningstar Category Rank (Percentile): 7
Technology and health-care stocks fueled this fund's 2013 return, with very strong stock-picking in both sectors. Many top contributors in those sectors are longtime holdings, including Google (GOOG), Priceline.com (PCLN), and Tencent, reflecting manager Larry Puglia's generally low-turnover strategy. But the fund also has benefited from less-traditional growth areas, such as financials, with a stake roughly twice that of the Russell 1000 Growth Index.
The fund is well-diversified and has generally controlled risk well: During Puglia's 20-year tenure, it has lost only about 86% as much as peers and the Russell 1000 Growth Index during downturns. That said, the fund isn't necessarily as much of a safe haven as one might expect from a "blue chip" fund. Its performance in 2008 was in its category's bottom third, for instance. Its above-average stakes in consumer cyclicals and financials could hurt in a market dip. Overall, though, the fund has certainly delivered over the long term. Puglia has led the fund since its 1993 inception, and since then, its 10.4% annualized return has beaten the Russell 1000 Growth Index by nearly 2 percentage points.
Senior fund analysts Gregg Wolper, Janet Yang, Katie Reichart, and Laura Lallos contributed to this Fund Spy.
Kevin McDevitt, CFA does not own shares in any of the securities mentioned above.