Fundmastery Blog

Kurt Brouwer May 14th, 2008

Writing in Money magazine, Jason Zweig penned a very laudatory piece on one of our favorite fund managers, Bob Rodriguez.

The best fund manager of our time (MONEY, April , 2008, Jason Zweig)

To invest in a mutual fund is to make a bet on the future. Whether that bet pays off is a function of how skillful the fund manager is, how lucky he is, how well the market does and how well the manager treats you.

The first two factors are very difficult to measure or predict, and the third is impossible to know in advance. But the fourth is quite easy to evaluate. You want a fund manager who will charge reasonable fees, keep his fund from growing too big for your own good, think independently and courageously and communicate his actions and intentions clearly.

You also want someone who will invest his own money alongside yours - and who knows how much it hurts to lose it. The best fund manager, then, combines a long and convincing track record of excellent performance with a fierce dedication to treating his investors fairly.

And the winner is…

Our vote goes to Robert L. Rodriguez of the FPA Capital and FPA New Income funds. Ever since mid-1984, Rodriguez, now 59, has led these two funds to the front of the pack, the investing equivalent of running two marathons at the same time. Overseeing both a stock and a bond fund is so hard that well over 99% of all fund managers lack the guts to even try it - and nobody has ever done both better than Rodriguez.

At FPA Capital (FPPTX), a fund specializing in smaller U.S. stocks, Rodriguez has outperformed Standard & Poor’s 500- stock index by an annualized average of 3.9 percentage points; he has beaten the Russell 2000 small-stock index by six points annually. And at FPA New Income (FPNIX), Rodriguez has never lost money in a calendar year; he has outlegged the Lehman Brothers aggregate bond index by 0.2 percentage points annually since 1984. In bond investing, a game of inches, that’s a country mile.

I remember a story Bob told us of what happened during the late 1990s growth stock boom. Obviously, a small cap value-oriented stock fund such as FPA Capital could not have been more out of sync when the market was dominated by high rollers such as Cisco, Microsoft, Dell, Juniper and so on. After a year or two of paltry returns, one of his institutional investors pulled their account and chastised Rodriguez for poor performance by implying that he just didn’t get it. That moment was no doubt personally difficult for Bob, but it probably was close to the bottom for his style of investing.

The Zweig piece continues:

Bob Rodriguez has achieved all this while steadfastly treating his investors fairly. Perhaps because he is the largest individual shareholder in each fund, FPA Capital charges only $8.60 in annual expenses per $1,000 invested (barely over half the average cost of a U.S. stock fund), and New Income costs just 0.62% in annual expenses.

Rodriguez also periodically closes his funds’ doors, ensuring that too much new money won’t flow in too quickly; FPA Capital has not accepted new shareholders since 2004 (though New Income is still open).

When the funds are open, he deters short-term traders with a 2% redemption fee on shares held for three months or less. (Because the funds are distributed by financial advisers, there’s also a maximum sales charge of 3.5% on New Income and 5.25% on Capital. But if you hold on for a few years, their lower annual expenses more than make up for the sales charge.)

This particular point — that these funds are load funds — is the only issue on which I really disagree with Rodriguez. I think it’s a mistake for them as a fund group.

…Last June, Rodriguez gave a speech that warned of the coming credit crisis so accurately that it reads with hindsight as if he had been peering into a crystal ball.

Taking his own warnings to heart, Rodriguez raised cash to levels high enough to withstand a nuclear war: 43% in FPA Capital and roughly 66% in New Income. In December he declared a formal moratorium on buying any stocks or high-yield bonds until he felt it was safe to invest again - essentially putting both portfolios into a state of suspended animation. As of press time he has not lifted that moratorium.

…Rodriguez has another strength: He knows how much it hurts to lose money. His grandparents, wealthy landowners in Mexico, were wiped out in 1916 when the government seized their assets as punishment for sympathizing with Pancho Villa’s revolutionary movement.

An investing junkie is born

Rodriguez grew up in Los Angeles, where his father worked as an electroplater. In fifth grade, assigned to write a letter to a stranger, he picked William McChesney Martin, chairman of the Federal Reserve Board. Martin replied personally, signing up Rodriguez as the youngest subscriber to the “Federal Reserve Bulletin,” and an investing junkie was born.

Fresh out of college in 1971, Rodriguez jumped into the hot growth stocks of the day. “I thought if you couldn’t compound money at 20% to 25% a year, you were basically incompetent,” he recalls.

Then came the bear market of 1973-74. His favorite stock, a recreational-vehicle company called Executive Industries, started dropping from his initial purchase price of $22 a share. He bought more all the way down to $8, when he ran out of money. (His average cost per share was in the low teens.) The stock hit bottom at 88¢. The memory still haunts Rodriguez, who explains with a bitter laugh: “When somebody says to me today, ‘This stock can’t go any lower,’ I say, ‘Au contraire!’ ”

The lesson didn’t stop there. “I learned that if you make a mistake and you don’t tear it apart to see what you did wrong, you’re going to repeat it in the future. I learned that fear is a terrible thing to have.” He adds, “The best way to minimize your fear is to have a solid understanding of the companies you invest in.”

The long and winding road from growth stock investing to value investing is one that has been traveled by other brilliant fund managers. For example, Shelby Davis (New York Venture Fund and Selected American Shares) is another who hit the wall in the 1970s and turned to a more judicious, value-oriented investment style.

Searching for answers in the library at the University of Southern California, where he was studying for his M.B.A., Rodriguez discovered Benjamin Graham and David Dodd’s Security Analysis. Graham and Dodd helped him realize that chasing hot stocks was no way to pile up cold cash; instead, Rodriguez began to look past the fluctuating prices of stocks to determine the enduring value of the underlying businesses.

He realized that Executive Industries, trading at less than $1 a share, had $2 a share in cash and $3.50 a share in real estate - plus an ongoing business that should bounce back once the recession ended. Instead of selling, he held on for dear life and eventually got out for around $22 a share, turning a nice profit on a stock that Wall Street had left for dead.

“I realized then,” he recalls, “that if I can survive the downturn I can live to participate in the upturn.” According to Rodriguez, a true contrarian has to feel comfortable being lonely. And that, he says, means you can shrug off three unpleasant questions. The first is “Don’t you know that…?” The next is “You’re buying what?” And the third is “Are you nuts?”

Sit tight and ride it out…

Such accolades do not come very often from a writer of Jason Zweig’s stature. Zweig is a prolific writer for Money, but he also has written and edited several books, his most recent being Your Money and Your Brain (Simon & Schuster, 2007).

The funds, particularly FPA Capital, have done well of late, but there will be a time when they are not in sync with the financial markets. With a stock fund such as FPA Capital, it is critical that anyone investing in it remain patient during periods when the fund is out of favor. I believe you will be well rewarded if you do.

For more on Rodriguez (see Bob Rodriguez — Are We Crossing The Rubicon? and Robert Rodriguez — Mutual Fund Switch Hitter).

• Investing , Money , Mutual Funds , Personal Finance
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