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Fund Spy

The Benefits of Strong Shareholder Communication

Some managers go the extra mile to inform you about your investments.

One of the things that we Morningstar fund analysts highlight in our Stewardship Grades is shareholder communication. If given a choice between great returns with lackluster information and lackluster returns but great information, most investors would probably choose the former. The trouble: You can't pick returns in advance.

You can, however, choose to invest with managers who in one way or another do a good job of explaining how they invest your money. When their funds are doing well, it's a plus. When their funds are lagging peers, it can be of huge comfort. Plus, some managers go farther afield, telling you how they personally are investing or what macroeconomic trends they're watching that are important to individual investors. The better a manager explains his strategy, the better job you can do using the fund. Ultimately, being a well-informed investor is your personal responsibility, but some fund firms make that job a lot easier for you to do. By now, regular readers of Morningstar.com know we dig the shareholder letters produced by Marty Whitman of Third Avenue, Bill Gross and Paul McCulley of PIMCO, and Chris Davis and Ken Feinberg of Davis Funds. So, here I thought I'd share a few highlights from other shareholder reports.

Individual Stock Information
For stock-picking junkies, almost nothing beats having a fund manager lay out his or her thesis on specific stocks. It gets you deep into the mind of the manager and thus truly helps you understand how the fund is supposed to work.

One of the tops in this field is Ariel Capital Management, home of  Ariel Fund (ARGFX) and Analyst Pick  Ariel Appreciation (CAAPX). As a part of their long, highly readable quarterly reports, the managers regularly include a full page of discussion of one stock, called a "Company in Focus," and four half-page discussions of others, called "Company Updates." The reasons for Ariel's enthusiasm for the stocks are very clear--and the material is aimed right at individual investors. Oftentimes, the firm lists its estimate of the intrinsic worth of a stock or at how great a discount the stock trades. I once asked John Rogers why he included this information, given that it essentially provides competitors with free research. He said that Ariel's team had asked themselves that question, but ultimately he felt his investors deserved the information.

While a bit less structured, the shareholder reports from Fiduciary Management Inc.--FMI--are also standouts in detailing the thought process for specific holdings in funds such as FMI Focus (FMIOX) and  FMI Large Cap (FMIHX). Ted Kellner, Patrick English, and crew want to invest in good businesses, and they often give multiple bullet points on why a firm has a good business, in addition to an overall thesis for the firm and stock. FMI is also quite good about explaining why it has sold various stocks, both due to success and failure.

Delafield Asset Management, home of the  Delafield Fund (DEFIX), is another boutique shop that really informs its investors about the rationale behind stocks in its rather compact (50 stocks or so) portfolio. Comanagers Dennis Delafield and Vincent Sellecchia are especially diligent about informing investors about recent purchases. Plus, the details for the stock purchases essentially back up the overview of the fund's philosophy and approach, which they also write about extensively.

A different twist on informing investors about stock-picking comes from Diamond Hill, which runs  Diamond Hill Large-Cap (DHLAX) and a closed Analyst Pick  Diamond Hill Small-Cap (DHSCX), among others. Another boutique, its shareholder communications don't give elaborate information on current holdings. Rather, its Web site has a calculator--The DH Valuator--that illustrates its intrinsic value models. You can input individual stocks to see how they score using its rubric. For those who want to get into the nitty-gritty, this is pretty cool stuff.

Winners and Losers
We like managers who own up to their mistakes and even draw some lessons from them. It's also instructional to hear why other names' holdings produced strong returns so that you can appreciate what the manager does well and what the drivers of the fund really are. A lot of fund families include this information, but some do it better than others. One key thing for us is balance: Some fund families seem to put a lot of emphasis on their best stocks, even when overall performance is poor.

A leader in this field is Brandywine, home of Analyst Pick  Brandywine Fund (BRWIX) and  Brandywine Blue (BLUEX). As a part of Brandywine's quarterly reports, the managers include a lot of information about what stocks did well and what didn't in their fast-trading strategy. That's crucial, as holdings come and go so quickly that shareowners could easily miss the fundamentals driving performance. A main piece is the full-page "Roses and Thorns," which details the five biggest winners and losers for the quarter for each fund. It breaks out the dollars made and lost but also the percentage gained and lost. Additionally, the Brandywine crew gives an explanation for why the stock worked or failed. For instance, in the Dec. 31, 2005, quarterly report, the managers explain that  CVS (CVS) didn't work out as they thought it would, so they moved on after losing money, while they stuck by  Bed Bath and Beyond (BBBY) because they felt the market had overreacted to its loss of business to a competitor.

When you're a Royce investor, a key issue isn't finding information, it's wading through it all. The firm's Web site has multiple reports for each fund, and as a shareholder you'll also get frequent mailings and e-mail messages. The funds' structures are sliced and diced multiple ways, so it's pretty easy to know what you're holding. On the Web "Profile" report, there's a tab for "winners & losers." The report lists the five best and worst stocks for the fund the previous quarter, reported in dollar terms. For instance, with  Royce Low-Priced Stock (RYLPX), there's a huge disparity between the winners and losers for the 4th quarter of 2005.  The biggest winner, biotech comeback story  Elan (ELN), gained nearly $19 million for the fund; the biggest loser,  Pier 1 Imports (PIR), lost less than $7 million.

News You Can Use
While we wouldn't suggest that all managers are in a good position to give broad financial advice, and while we don't think of it as a core responsibility, a few managers go the extra mile and provide great food for thought.

Thomas Putnam, chairman at FAM funds, writes a biannual shareholder letter that he calls "Tom's Letters from Cobleskill." They don't often--if ever--deal specifically with individual stocks or the  FAM Value (FAMVX) or  FAM Equity-Income (FAMEX) funds. Rather, they're folksy, down-to-earth, often personal reflections that deal with the bigger picture. For instance, in his September 2005 letter, Tom takes on the issue of how much one profits from selling a home. He notes that, unlike with a mutual fund, a person spends a lot of time on upkeep and there are a number of costs that current owners tend to discount (such as closing costs). His March 2005 letter compares forecasting the weather to forecasting the stock market, basically concluding that both are similarly tough to do. That's why he keeps an umbrella in the car and has his FAM team remain disciplined in a long-term approach.

If there is any manager who reveals more personal information than Bridgeway's John Montgomery, we're not sure we know who it is. He publishes his annual salary, for instance--which investors in his funds should know is modest and thus a key part of the reason the funds are so cheap. Even better, he shares his personal target asset allocation, which he divulges in semiannual reports. He can only invest in the stock market via Bridgeway funds, and he tells what he owns and in what percentages. It's a bit complicated, with listings for both taxable and tax-deferred investments over several time periods, and it's also quite aggressive. Still, he tells and shows how he's lightening up on what has done well of late, meaning he's showing the need to be disciplined in one's asset allocation. And he also delivers other gems, as in his 2003 Semi-Annual Report, where he noted that he favored  Aggressive Investors 2 (BRAIX) over the very similar  Aggressive Investors 1 (BRAGX), because it held less money and was thus more nimble.