BOSTON -- The stock market posted impressive returns last year, even with the presidential election and the resulting political gridlock. It was a welcome change from 2011, when the market rose only slightly.
The two top-performing stock mutual funds of last year posted returns greater than 35 percent, more than twice the gain of the broader market. But go back further than last year and their recent strength doesn't look as impressive. Both funds performed dismally in 2011.
For long-term investors, it's a reminder of the importance of patience. Just as it's rare for fund managers to pick the top-performing stocks year after year, it's unusual for them to repeatedly post disappointing numbers. The market shifts, and many of the worst performers in a given year fare much better the next. The trick is to find funds that outperform a majority of peers more often than not, and stick with them.
In 2012, the Standard & Poor's 500 index returned 16 percent, far better than the previous year's 2 percent rise. Stocks surged despite modest economic growth and a slowdown in corporate earnings. There were plenty of risks: the European debt crisis, slower Chinese economic growth and the partisan feud over restoring this nation's shaky fiscal health. Those worries were offset by a rebounding housing market and continued efforts by the Federal Reserve to stimulate the economy.
Below is a look at three of the top-performing stock funds of 2012, in order of their returns:
Miller back on top
Bill Miller has a reputation to live up to. He became famous for beating the S&P 500 for 15 straight years through 2005. But his Legg Mason Capital Management Value Trust fund began faltering in 2006, and Miller left that fund last April.
He remains manager of Legg Mason Capital Management Opportunity (LMOPX), assisted by Samantha McLemore. The fund posted a 39.6 percent return last year. That's the top result among diversified U.S. stock funds with at least $100 million in assets, according to Morningstar.
It's a stark contrast to 2011 when the fund dropped nearly 35 percent. That was the biggest loss in Morningstar's mid-cap value stock fund category.
Performance turned around in 2012 because a handful of homebuilder stocks had breakout years. PulteGroup, the biggest holding in the $1 billion fund, shot up 188 percent and was the top stock in the S&P 500 last year. A couple other homebuilders in the fund's top 10 holdings, KB Home and Lennar, jumped 135 percent and 97 percent, respectively.
Those strong gains reflect what Miller and McLemore call a virtuous cycle: An improved housing market fuels increased consumer spending and a stronger economy, leading home prices to climb even further.
"While we were early to invest in housing, the recovery has clearly begun, helping the portfolio in 2012," McElmore said. "Judging from history, we are in the early stages of a long, enduring improvement, which should have positive implications for the economy and our holdings."
Bruce Berkowitz' Fairholme Fund (FAIRX) rose 35.8 percent, the top result among all large-cap value stock funds.
It was the exact opposite of 2011, when Fairholme was the worst performer in its category, losing more than 32 percent. That was an unwelcome surprise for Fairholme investors who earned an average 13 percent a year from 2000 through 2009 -- 14 percentage points ahead of the S&P 500.
The reason for the worst-to-best results? About three-quarters of Fairholme's portfolio was recently invested in financial stocks such as insurer AIG and Bank of America. Those two picks lost more than 50 percent in 2011. But last year, financial stocks led the industry groups in the S&P 500 and Berkowitz' favorites were among the biggest winners. Bank of America surged 109 percent, and AIG 52 percent. Berkowitz holds a small number of stocks in his fund; at latest count, it had just 11.
Berkowitz didn't return a message seeking comment on his 2012 results.
However, Fairholme's recently inconsistent results have been too volatile for many investors. They've withdrawn billions of dollars from the fund, and its $7 billion in assets is less than half its total just two years ago.
Little-known fund has another big year
The Matthew 25 fund (MXXVX) posted a return of 31.6 percent, the top result in the large-cap growth stock category.
What's more remarkable is that the fund also finished in the top 1 percent of its category in 2011 with a 10.5 percent return, and in the top 2 percent in 2010, with a return of nearly 32 percent. It's been a big comeback for a fund that underperformed during the financial crisis of 2008.
The fund is named after a chapter in the Bible's Gospel of Matthew, consisting of three parables of Jesus. While the fund doesn't invest according to religious-based stock-picking criteria, the parables reflect values that fund manager Mark Mulholland strives to live by as a Roman Catholic.
He attributes his 2012 result in part to Apple, the fund's largest holding at 15 percent of the portfolio. The maker of iPhones and iPads gained 31 percent last year, despite falling in the final three months of the year. Mulholland still likes Apple, a stock his fund has owned continuously since early 2008.
"It's an exceptional company at an incredibly cheap price," he said.
The fund's second-largest holding, Cabela's Inc., surged 64 percent last year to nearly $42 a share. Mulholland first began buying the stock in the outdoor sporting goods retailer in 2008. Back then, shares briefly sank below $5.
Mulholland is the fund's sole manager, and he and his wife are its biggest individual shareholders. He doesn't have analysts to aid his stock-picking. Fund assets recently climbed to $278 million, up from $63 million at the end of 2011.
But he's not expecting Mathew 25's standout performance over the past three years to continue. That's a relatively short span for investors saving for retirement, he notes.
"In a given year," he says, "a fund's performance is often a matter of luck."