Fund managers with broad investment latitude chart their course.

    They're an iconoclastic bunch unbridled by benchmarks, and at a time when most funds fit squarely into a neat style box they proudly defy categorization.
    Depending on what they're aiming to accomplish, managers of funds that have a flexible investment mandate can move from large to small companies, stocks to bonds, or value to growth strategies. These "go-anywhere" funds are smaller in number than the majority of actively managed funds, but they're far from a vanishing breed. Some 1,892 funds fall into Lipper's multicap core, multicap growth, or multicap value categories. Flexible portfolios, which can also shift asset allocations, account for another 145 funds.
    Investors seem increasingly inclined to put market capitalization calls and other decisions in the hands of professionals. Diversified stock funds segregated by market capitalization saw $41.44 billion in outflows during the first ten months of 2006, compared to $68.78 billion of inflows into multicap core, multicap growth and multicap value funds.
    Lipper senior analyst Jeff Tjornehoj believes investors like the latter group because they are willing to sacrifice the predictability of a fund that covers one corner of the market for a more consolidated alternative that spans a broader universe. "They're viewing these funds as a simple, diversified way to a piece of the stock market," he says.
    At least part of the draw also may be the enduring allure of managers who invest decisively, often with their own money. "I have 98% of my own liquid assets in this fund," says Janus Contrarian Fund manager David Decker as evidence of his motivation to succeed for himself and the $4.5 billion fund's shareholders. Some of them include financial advisors, who he believes might view his charge as "a good satellite for a core asset allocation model."
    History shows that in some cases, boundaries are a good thing. Over the years, many fund managers have taken wrong turns with results ranging from disappointing to disastrous by moving from small to large companies, darting in and out of cash at the wrong times, betting on bonds, or moving into hot sectors at the tail end of a bull market. The late 1990s saw the birth of the phrase "style drift" to label such practices.
    But there have been some notable success stories among funds with flexible investment mandates, such as Martin Whitman of Third Avenue Value and Bill Miller of Legg Mason Opportunity Trust. Others, such as Michael Avery and Daniel Vrabac of Ivy Asset Strategy fund or Donald and Craig Hodges of Hodges Fund, are less well known but have compile admirable long-term track records as well. Below, the managers of four multicap or flexible portfolio funds with strong long-term performance records discuss where they're investing, and what they're avoiding.

Janus Contrarian (JSVAX)
Lipper Category: Multicap Core
Returns as of 12/31/06
    One-year    Three-year    Five-year
    24.58%     21.01%     15.69%

    Decker looks for stocks with what he calls "asymmetrical risk profiles," meaning they have more upside potential than downside risk. Over the last two years his search for out-of-favor companies with strong cash flows and unrecognized value has frequently led to foreign stocks, where the fund has 40% of its assets.
    Company size spans a broad range as well, with those having more than $10 billion in market capitalization accounting for 46% of the portfolio. Smaller companies with between $1 billion and $5 billion in market capitalization weigh in at 35% of assets, followed by mid-sized companies at 16%.
    Emerging economy infrastructure plays figure prominently in the portfolio. "The economies of most countries in Asia are exceptionally strong, and they're getting stronger," says Decker, who sees overlooked opportunities in the real estate, power and banking industries. The fund's fifth-largest holding, India's ICICI Bank, represents an emerging market opportunity with a strong return on equity, good management, a loan book that's growing at a rate of 25% a year and a low level of nonperforming loans.
    In this country, Decker has been picking up stocks hurt by rising fuel costs and faltering real estate values. He recently added to the fund's stake in Florida land-owner St. Joe after investors fled the stock because of concerns about the state's housing market. He views the correction as an overreaction, and reasons that the stock price does not reflect the value of the company's land. He also established a position in Plum Creek Timber, which declined substantially over the summer as lumber prices dropped. Decker says the company is well positioned to ride out the downturn because it can sell land for development where real estate values have increased, and keep their trees up in other areas until lumber prices improve.

Hodges Fund (HDPMX)
Lipper Category:  Multicap Core
Returns as of 12/31/06
    One-year    Three-year    Five-year
    17.77%    19.78%    17.95%

    Despite the fact that the Hodges Fund has swollen from $100 million in assets in May 2005 to $587 million today, Donald Hodges says he has no specific formula for picking stocks. "There can be 25 or 30 reasons why a stock is a good buy," says Hodges, who managers the fund with son Craig and four analysts. "For some, it's underlying assets. For others, it's strong growth."
    While Hodges will invest in all sizes of companies, whether they have growth or value characteristics, he draws the line at those that produce alcohol or tobacco. He sold Sirius Radio because of its association with controversial radio personality Howard Stern. "I've been in this business for 46 years and it's always been important for me to be proud of the companies I invest in," he says.
    XM Satellite Radio Holdings, a recent purchase, represents what he considers the confluence of old-fashioned values, new technology and reasonable price. Hodges originally bought the stock beginning in late 2000, but sold it in 2002 after more than doubling his investment. By the fall of 2006, the price had plummeted over concerns about how long it was taking for the company to make money. Hodges jumped in again because the stock is so cheap, and the company is adding subscribers at a healthy clip. Another recent small-company purchase, Pricesmart, is a warehouse grocery chain with operations in Latin America that hasn't hit the radar screens of Wall Street analysts.
    Larger company holdings include Texas Industries, a company that produces almost one-third of the cement in Texas and is also active in California. Because demand for cement outstrips supply, the company has been able to raise prices three times over the last year. Railroads such as Burlington Northern Santa Fe and Union Pacific also figure prominently in the portfolio. "Railroads have moved from a cyclical to a growth industry," he says. "Materials such as coal or ethanol can only be transported by train, and goods from Asia need to be moved from California to other markets. There are no new railroads being built so there is ample pricing power, and higher energy costs are being passed on to shippers."

Ivy Asset Strategy Fund (WASAX)
Lipper Category: Flexible Portfolio
Returns as of 12/31/06
    One-year    Three-year    Five-year
    19.78%    18.26%    13.70%

    Since 1997, co-managers Michael Avery and Daniel Vrabac have tested the boundaries of this asset allocation fund's fluid parameters, which allow them to be "anywhere from 0% to 100% in any major asset class," says Avery. They often take full advantage of that flexibility, as they did in May when they began moving aggressively into cash as concerns about overheating arose in sectors they had invested heavily in, including materials, energy and industrials. By mid-September, the cash stake had peaked at 45%.
    They began moving back in to the market later in the year as prices at the pump began declining and consumers looked ready to dig into their wallets again, but Avery says he's ready to shift the other way if he thinks market conditions warrant it. "At some point, the Fed will have to address the core rate of inflation, and the market has had a great run over the last four years," he says. "My feeling is that the level of cash is more likely to increase rather than decrease in the future." The fund, which has had as much as 70% of its assets in bonds in the past, has only a smattering of short-duration securities now because of concerns over rising interest rates.
    Despite allocation shifts that make the fund more volatile than a typical asset allocation offering, the theme of investing in companies that stand to benefit from the emerging middle class in Asia has remained constant over the last several years. With demand for gold likely to rise in India and China, the fund has 14% of its assets devoted to the metal in the form of gold mining companies, exchange-traded funds that move directly with the price of the commodity, and even gold bullion that the firm stores in a bank vault. Energy stocks account for another 13% of assets. About half of the fund's equity stake is in foreign companies, with recent purchases focusing on health care, entertainment, financial services, telecommunications and other sectors that stand to benefit from Asia's increasing spending power.

Heartland Select Value (HRSVX)
Lipper Category: Multicap Value
Returns as of 12/31/06
    One-year    Three-year    Five-year
    16.69%    15.72%    12.61%

    Heartland Select Value Fund's managers scout out opportunities among small-, mid- and large-cap companies that have low prices in relation to 2002 the fund's team of portfolio managers liked small companies, which occupied more than half the portfolio. Today, that allocation is down to 16%, while large caps are up to 48% of assets. The duration of the small-cap rally and more compelling values among larger companies account for the change, says Ted Baszler, a member of the portfolio management team. "It appears that the economy is slowing down, and in that kind of environment we want to stick with larger, well known names," he says.
    Banks such as fund holdings Bank of America and SunTrust Banks came under pressure in 2006 because an inverted yield curve put a squeeze on profits. Although some of the stocks are selling at below-market multiples, they offer attractive dividends and prospects for earnings growth as short-term rates move down a bit, while long-term rates move up. "Going into 2006, the focus was on the Fed tightening cycle. Now that the housing bubble has popped, the question is when short-term rates will start to come down," says Baszler.
    Despite trouble in the housing market, the fund added construction stocks DR Horton and Toll Brothers to the portfolio at the end of the summer, when they were selling at around book value. Although Baszler expects the housing market to remain soft for most of the year, he says that given the bargain prices of the stocks, he's "willing to ride out the current housing cycle."