Successful stock picking often relates to a manger's strong focus on its sector of specialization. The accumulation of deep knowledge takes years but can be rewarded with an exceptional ability to select truly undervalued companies in the sector. The proof is in a fund's consistent outperformance of the benchmark.

In the chart above you can see the Fund in question specializes in the healthcare sector. For more than 18 years the managers have analyzed over 500 companies in pharmaceuticals, biotech, medical equipment, hospitals, etc. They conduct their research by attending industry conferences and establishing direct contact with key executives. Since inception 10 years ago the Fund has outperformed the S&P 500 by 242% and the S&P Global 1200 Healthcare Index by 224%.

Just as in art, the ideal of perfection is not achievable. Constant outperformance cannot be maintained. Periods of underperformance inevitably occur, challenging one's assessment of the quality of a fund. But high quality managers outperform more frequently than underperform and periods of outperformance last longer. The chart illustrates the alternation of fortunes throughout the Fund's life.

An analysis of the Fund's historical portfolio composition reveals a great deal about cycles of underperformance. In certain cases it comes at a time of low net long exposure (on the chart, the vertical gray bands a, b, and partially d, e, and h) that signifies a positioning of lower risk rather than real underperformance. In other cases it is a product of the lagging returns of key positions (bands c, f, g, and i) - true underperformance.

For this Fund the total period of true underperformance does not exceed a quarter of its life. The longest true underperformance streak is two quarters while the longest outperformance lasts six. Such parameters should not cause an investor undue concern about the quality of the manager.

The volatility of a fund inevitably rises when its sector of focus experiences turbulence. A high quality fund will demonstrate stability in such circumstances. The Fund in question outperformed the index in both bear market periods (1 and 3 on the chart).
A clear understanding of alternating performance metrics over a longer period can bring investor comfort and encourage the patience required to achieve a winning result.


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