Two Good Funds on Sale

08/20/2008 12:00 am EST

Focus: ETFS

Russel Kinnel

Editor, Morningstar FundInvestor

Russell Kinnel, editor of Morningstar FundInvestor, says the recent selloff has made some mutual funds' valuations very attractive.

It's raining bargains.

All over the world, markets have been brutal. Surging oil prices and a financial crisis have crushed stocks from Wall Street to Hong Kong to London. Foreign and broad domestic-market indexes are down about 13% this year and more than 20% from their October peak.

While the economic news is grim, the silver lining is that stocks are significantly cheaper across the board. If you are still in the accumulation phase or have a lot of money parked in cash for just such a selloff, this is great news. Of course, while we know that stocks are cheaper, we don't know for sure if they are cheap. That remains to be seen.

Crunching the data, I see that many mutual fund portfolios are significantly cheaper than they were based on forward earnings estimates. If you want a break on valuations, take a look at funds whose price/prospective earnings have fallen dramatically from this time last year. The ratio is built using Wall Street analysts' forward earnings estimates and then aggregated for all the holdings in a fund portfolio.

I chose those with the biggest percentage decline rather than the absolute lowest P/Es because the latter measure would just turn up the usual deep value suspects. By looking at those whose P/Es have declined the most on a percentage basis, we're seeing which funds of all stripes appear to have historically cheap portfolios. I limited the search to those with recent portfolios from May, June, or July.

Osterweis (OSTFX) is a compelling option trading for just 12x next year's earnings. We added this fund to our picks list this year following a visit out to the San Francisco-based shop. Lead manager John Osterweis has a laser-like focus on a company's cash flows. If everything looks strong, he'll buy and hold for the long haul. Only a few stocks meet his criteria, but they come from a wide range of industries and market-capitalization ranges.

Ariel (ARGFX) is another good value, with a portfolio trading 31% cheaper than a year ago. That's welcome encouragement for shareholders who have suffered through lean years of late. The market is viewing John Rogers' picks like Hewitt Associates (NYSE: HEW) and Anixter International (NYSE: AXE) as value traps, but if the earnings hold up at those companies, a rebound should be on the way.

I don't know where the market will go next, but history tells us that you don't have to buy at the bottom of a bear market to earn a handsome return over the long haul. Those who buy now will probably be pleased with their decision come 2018.

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