Leaders, Laggards, and Upgrading

As we approach year-end, we'll be seeing the usual articles that take a look back at the wild ride that has been 2009. Here's one from Morningstar naming Four Big Mutual Fund Surprises of 2009.

On the pleasant-surprise side, Upgraders will find two familiar names. Brown Capital Management Small Company (BCSIX) was added to our recommended list in September of 2008, so we've been fortunate to enjoy the ride ... the fund is up 63.3% over the past 12 months (through yesterday). That's a full 26% (!) better than the market during the same period. M* applauds the fund managers' "steady approach," saying it means...

...they are likely to stick with a company even when it hits a pothole and are unlikely to sell a stock because it has risen a lot. The fund's lack of energy stocks helped it keep its losses to 30% in 2008; solid sales and profit gains among its holdings helped propel the fund to a nearly 35% gain this year. Brown Small Company's long-term record is excellent, although it achieves its returns in fits and starts.

Notice the reference to "fits and starts." Upgrading helps us avoid most of the "fits" and enjoy most of the "starts." We hope this will be the case with Oakmark Select as well, also favorably mentioned in the article and a recent addition to our Upgrading portfolio.

In the M* doghouse is Bridgeway Aggressive Investors 2 (BRAIX), a fund that we held in 2007-08 until it began underperforming its peers. Since we sold it in October of last year, it has continued that relative weakness, losing 21% over the subsequent 13 months compared to a loss of 11% for the average small/growth fund. M* says:

John Montgomery, who launched Aggressive Investors 2 in 2001, uses sophisticated computer programs to pick stocks. But quants were hurt by the sheer speed of events during the financial crisis and by massive redemptions from hedge funds that employ similar tactics. Montgomery is tight-lipped about his blackbox models, so investors face a challenge in deciding whether to hold or fold.

Yes, most investors "face a challenge" with "hold or fold" decisions because they have no firm selling discipline in place. But we had no such difficulties making that call last year when the fund slipped out of the top 25% in the momentum rankings.

Upgrading is not a perfect system. We all know that. But it is an effective system for selecting which funds to buy and knowing when they need to be sold. Given its simplicity, ease of implementation, and excellent track record, the average investor can't ask for much more than that. Or so it seems to me.
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Austin Pryor is the founder and publisher of the Sound Mind Investing newsletter and website. Visit www.soundmindinvesting.com to learn more.