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While we normally focus on individual stocks, from time to time The Turnaround Letter likes to look at mutual funds that focus on turnarounds. Mutual funds can be attractive because a single fund can provide fairly broad diversification. Unfortunately, there are very few mutual funds that really focus on turnaround investing. In fact, out of the thousands of mutual funds out there, we could only find a dozen, all of which are detailed in our contrarian investing newsletter. Even in those funds, turnaround investing is usually not their principal objective: In most cases, it is just one of several strategies that the fund manager pursues.
In some ways the scarcity of turnaround-oriented funds just validates our investment philosophy that turnarounds represent an inefficient--and therefore potentially very profitable--niche in the securities markets. Even professional investors tend to shy away from turnarounds because they require a somewhat different analytical approach from more mainstream stocks.
Another reason why there are very few turnaround mutual funds today is that there is no index of turnarounds. Today, most mutual funds (and the people who sell the funds) want to compare their returns to a certain benchmark, usually a well-known index like the S&P 500. As a result, most fund managers tend to hug their benchmarks fairly closely. These fund managers are risk averse. They want to keep their jobs, after all; and they give up the opportunity to outperform their benchmark in exchange for reducing the risk of underperforming. Since turnaround stocks are underrepresented in the major benchmarks, fund managers are hesitant to buy them. The managers of these mutual funds discussed are brave enough to put at least a portion of their portfolios in turnaround situations, and many of them have posted strong returns over the years because of that.