: You can beat stock market indexes — this fund manager has, and this is how she and her team did it

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Investing is a tough game. That’s why so many mutual funds lag behind their indices.

So when you find a fund with a great record, it pays to investigate what the fund managers are doing — to learn some lessons.

The American Century Focused Dynamic Growth Fund

fits the bill. The $2.8 billion fund beats its Russell 1000 Growth Index by over 6 percentage points annualized over the past three and five years, according to Morningstar. It outperforms its large-growth category by 8.6 percentage points annualized over five years. It has a reasonable 0.65% expense ratio.

The fund is co-managed by Prabha Ram, who I recently caught up with. Raised in India, Ram came to the U.S. as a teaching assistant at the University of Maine, where she earned a master’s degree in computer science. She went on to receive an MBA at the Wharton School at the University of Pennsylvania. Ram and three other portfolio managers have led this fund since 2016.

Here are the five key takeaways, with examples of specific stocks.

1. Own companies that can “land and expand” in big markets

Even though we’ve been in the digital age for years, many small companies still do much of their business on paper. Bill.com

wants to change that. The company was founded by CEO René Lacerte, who in the late 1990s started the online payroll company PayCycle, which was acquired by Intuit.

Bill.com helps small companies go digital in accounts payable and receivable payments. But that’s just the start. Once inside a company, Bill.com digitizes other areas like cash and expense account management.

Bill.com “lands and expands” at clients, but it also uses their business partners to create a network of leads.

“Every vendor is a network member, even if it is not a Bill.com customer,” says Ram. This network has about 2.5 million members. Bill.com also gets prospects from its partners, including Bank of America
JPMorgan Chase

and American Express
Sales grew 45% in the first quarter.

Founder-run companies such as this one are worth considering because they often outperform.

2. Seek out innovators

Ram’s portfolio contains obvious innovators, including Tesla

and Alphabet
her top three positions. Let’s look beyond technology — to beer.

Back in the 1980s, Boston Beer founder Jim Koch began taking share from beer giants Anheuser-Busch InBev

and Heineken

by rolling out successful “craft” brews, starting with Samuel Adams. Koch helped invent the craft brew category, essentially taking the country back to pre-Prohibition days when the U.S. had hundreds of regional breweries making more flavorful beers for local tastes.

Boston Beer stock did very well, but then it stalled during 2015-2017 as beer sales overall went flat. In response, Boston Beer helped put a new category on the map — with its Truly Hard Seltzer brand rolled out in 2106. It remains one of the leading hard seltzers.

“We were drawn to the company because of its history of innovation,” says Ram, referring to her fund’s early position from the second quarter of 2016. “The stock was doing poorly because the beer market was flattening, but they were coming up with Truly Hard Seltzer. Truly was more successful than we anticipated. It created a new category.”

This penchant for innovation at Boston Beer has helped keep Ram’s fund in the name. Other successful Boston Beer brands include Twisted Tea, Angry Orchard and Dogfish Head.

A key takeaway here is that to find innovative companies, look for the ones led by people who have demonstrated a knack for innovation in the past. Innovative managers tend to keep on innovating. Boston Beer continually tests new seltzers, beers, hard ciders, distilled spirits and other drinks. Shareholders are betting they will come through again.

They’ll need the help. Boston Beer shares fell 20% on July 23 because so many competitors entered the hard cider niche. Sales grew 33% but net income fell 1.6% as the company jacked up advertising costs to try to combat the competition. The company slashed estimates for the year on an expected slowdown in sales growth.

But don’t count out this innovator yet.

“We recently announced plans to develop new innovative beverages with Beam Suntory that we are planning to launch in early 2022,” Boston Beer’s Koch said. Beam Suntory sells Jim Beam whiskey and other brands of spirits. “We believe these new beverages will further demonstrate our ability to innovate and grow our business as drinker preferences evolve.”

3. Look for companies that can create and dominate a niche

For years as the gig economy emerged, the big credit card companies didn’t really care that much if the local yoga instructor could accept payments with a credit card. Square

recognized this as an opportunity. So it launched its card payment device business in 2009. Since then, it has grown by taking on larger customers, and expanding into new lines of business in financial services such as cash management, debit cards loans and tax filing. Transaction-based revenue grew 27% in the first quarter, and subscription and services revenue soared 88%.

This is a great example of a company that created a business niche. But it’s also a “land and expand” company because it grows by offering customers new services. Both qualities help companies maintain the competitive advantage Ram likes see in investments.

4. Buy companies in the early stages of rapid growth

One way to find these is to identify companies developing products that will transform an entire industry. Ram thinks that is the case with Alnylam Pharmaceuticals
It’s developing novel therapies base on a technique called RNA interference (RNAi). Inside the body, messenger RNA (mRNA) encodes proteins we need, based on signals from RNA. Sometimes mRNA gets the signals crossed, and it encodes flawed proteins. This causes diseases.

Alnylam has developed a way to tweak the RNAi pathway to silence the flawed signaling and block the creation of disease-causing proteins. So far, Alnylam has four approved RNAi-based medicines that treat rare hereditary diseases. The company has a dozen other therapies in clinical studies, including six in late-stage development.

“This is a completely new area of therapeutics,” says Ram. “It is a platform of products that can treat a variety of conditions.”

5. Hold stocks for the long term

All of the names above are large positions in Ram’s fund, which tells me that Ram and her team think they have considerably more upside. If you buy any of them, though, remember you have to do so with a multi-year time horizon. That’s what Ram’s fund does. It has a low annual portfolio turnover of 27%. It’s important to have a long-term view, because it is so tough to call short-term moves in the stock market or in stocks, and you need to give companies time to develop.

Michael Brush is a columnist for MarketWatch. At the time of publication, he had no positions in any stocks mentioned in this column. Brush has suggested BAC, JPM, AMZN, GOOGL, TSLA and ALNY in his stock newsletter, Brush Up on Stocks. Follow him on Twitter @mbrushstocks.