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Is Neuberger Berman's Success for Real?

This hot fund shop is on the right track.

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You may not have noticed it, but one of this year's hottest mutual fund shops has been Neuberger Berman. Of the 12 Neuberger funds that Morningstar writes about, eight have returns ranking in their category's top quartile for the year to date through Sept. 28, 2005, and three-- Neuberger Berman Genesis (NBGNX),  Neuberger Berman Guardian (NGUAX), and  Neuberger Berman Partners (NPRTX)--rank in the top 10% of their categories. As of last Thursday, the Partners fund had the third-best year-to-date record out of the 585 large-blend funds in Morningstar's database.

We don't put much stock in flashy short-term results, preferring instead to focus on a fund's strategy and longer-term performance. When looked at in that way, though, Neuberger still looks pretty impressive. This venerable shop has been going through some changes lately, but the overall effect has been positive, and the firm looks like it's heading in the right direction.

The Neuberger Way
In terms of strategy, the key funds in Neuberger's lineup are distinguished by a combination of low turnover and bold sector bets. Managers have a lot of conviction in their picks--there are no wimpy index-huggers here--and once they own a stock, they tend to hold onto it for a long time. The most extreme example is  Neuberger Berman Focus (NBSSX), now lead-managed by Bob Corman after Kent Simons's retirement last month. About 80% of the fund's assets are in financial and semiconductor stocks (including almost 45% in just three stocks), and turnover has averaged less than 30% during the past three years. Similarly, both the large-cap Partners fund and the small-cap Genesis fund have huge stakes in the energy sector relative to their peers, which is one of the main reasons they're both doing so well this year. Partners manager Basu Mullick has also made a big bet on homebuilders, which make up half of the top 10 holdings. Yet these funds haven't just recently latched onto hot areas of the market; they've owned some of these stocks for years, and their turnover has been correspondingly low (23% last year for Genesis, 65% for Partners).

Such sector bets are tough to execute well consistently, and they certainly involve risks. There's a real risk that energy stocks could take a beating in the short term if oil prices fall, and they're certain to at least slow down at some point. The same goes for Mullick's homebuilders. Yet over the long term, these funds have compiled excellent records by sticking to their convictions. Partners has been a solid top-quartile fund since Mullick joined the management team in 1998, and its five-year record is among the best in the large-blend category. Genesis has been one of the small-blend category's best performers over the 11 years that Judy Vale has been in charge. (Co-manager Bob D'Alelio joined her in 1998.) Focus has had plenty of ups and downs, but it has beaten its large-growth peers over all trailing periods, with one of the category's best records over the trailing three years. Those records show that these funds aren't just flashes in the pan, and the length of the managers' tenures is encouraging.

Changes Afoot
While the core of Neuberger's approach has stayed the same, there have been some changes in recent years. One is a gradual shift in the direction of growth investing, so that the shop as a whole is less value-oriented than it once was. Of the 12 stock funds in Neuberger's lineup, the only one that currently falls into the value column of the Morningstar style box is Neuberger Berman Real Estate (NBRFX); all the rest are in the blend or growth columns. As recently as 2002, all four of Neuberger's main large-cap offerings--Guardian, Partners, Focus, and  Socially Responsive (NBSRX)--were categorized by Morningstar as large-value funds. Now all four are in the large-blend category, and Guardian and Socially Responsive (both managed by Arthur Moretti) have often edged into growth territory. This doesn't mean that the managers are no longer concerned with valuation--they certainly are, some more so than others--but they've become a bit more willing to pick up growthier stocks, such as those technology and energy stocks mentioned above.

Also, the past five years have seen a number of new managers on Neuberger funds, most of whom fit into the Neuberger mold while adding their own touches. For example, Arthur Moretti joined Socially Responsive as comanager in 2001, taking over the lead role at the end of 2003, and he took over the Guardian fund at the end of 2002. He takes the same high-conviction, low-turnover approach as his colleagues, but his main sector bets have been in technology and media stocks, which is why the fund looks growthier than the other core Neuberger offerings. So far, Moretti has been doing a bang-up job: The Guardian fund is on pace this year to finish in the top 10% of the large-blend category for the third straight year.

Neuberger has also built up a Chicago-based growth team that shows considerable promise. In 2001 they bought the small-growth  Fasciano Fund (NBFSX), which Michael Fasciano has run since 1987 using a cautious, low-turnover approach that meshes well with the rest of the Neuberger lineup. Fasciano has put together a fine long-term record with very low volatility, and we have long been fans of the fund. Then at the end of 2002, Neuberger lured over a team from Northern Trust to run their struggling  Century (NBCIX),  Manhattan (NMANX), and  Millennium (NBMIX) funds. That team has greatly toned down those funds' risk and put them on a more solid fundamental footing. After a slow start that coincided with 2003's speculative rally, the funds have been performing quite well the past couple of years, and we've become increasingly optimistic about their long-term prospects.

On the flip side, Neuberger has lost a couple of talented managers this year. In April, Andrew Wellington, manager of the mid-cap  Neuberger Berman Regency (NBRVX), left Neuberger to manage money for a private equity firm. He was replaced by Basu Mullick, who is now running both Partners and Regency. Then in September, Kent Simons of Neuberger Berman Focus retired after 17 years managing the fund. Bob Corman, Simons' comanager for the past two years, has now taken over as lead manager. In both cases, the funds appear to be in capable hands, but it's still not a good thing when a fund shop--especially one as small as Neuberger--loses two managers in six months.

The Lehman Factor
Looming over all these developments is Lehman Brothers' purchase of Neuberger Berman almost two years ago. Historically, we at Morningstar have tended to react with skepticism when a big financial conglomerate takes over a smaller fund shop. New owners can sometimes disrupt a shop's corporate culture, which can cause key personnel to leave. It's also not uncommon for new corporate owners to jack up fees in an effort to boost profits, even though such moves are bad for fund shareholders.

Fortunately, none of that has happened so far since Lehman took over Neuberger. Lehman has taken a very hands-off approach, basically allowing Neuberger president Peter Sundman to run things the same way he did before the merger. That's not all that surprising, given that one of the main reasons for the merger was Neuberger's expertise in managing equity portfolios, an area in which Lehman doesn't have a lot of experience.

Even better, fears about possibly higher fees have not been borne out. In fact, expenses for Neuberger funds have gone down, pretty much across the board, since Lehman took over. Expenses at the shop's three bond funds have remained the same, but all 12 of its stock funds had lower expense ratios in 2004 than they did in 2003. In some cases these were small reductions of one or two basis points, but others were more substantial.  Neuberger Berman International  (NBISX) saw its expense ratio go from 1.70%, somewhat high for the foreign small/mid-growth category, to 1.40%. We had complained in the past about the relatively high 1.50% expense ratio of the Regency fund, but a recent fee waiver means that shareholders are now paying 1.25%, about average for mid-cap funds.

Expense reductions are something we always like to see, and those developments have added to our sense that Neuberger is on the right track. We've generally been impressed with the managers, and the firm has avoided major pitfalls as it has gradually made changes without losing its essential character. For now, it remains a nice little shop that hasn't let success spoil it.

David Kathman does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.