Top-ranked fund manager: How I survived the wild week

August 15, 2011, 10:27 PM UTC

By Scott Cendrowski, writer-reporter

FORTUNE — By 2 o’clock last Wednesday, Tom Forester was feeling like a hero. The investor, the only stock mutual fund manager to make money in 2008, had just spent almost $10 million over 24 hours buying stocks. The Dow Jones Industrial Average was showing big gains since its low that day. Then, in an instant, the index plunged 350 points and finished deep in the red. “And we’re thinking, uh oh,” says Forester, whose Forester Value fund (FVALX) is beating 98% of rivals this year.

To understand how bizarre last week was not just for ordinary folk but even the planet’s smartest investors, Forester’s story is illustrative. He’s not a day trader like many on Wall Street. He’s a laid back Midwesterner who lives outside Chicago. He drives to work everyday in a 2006 Acura S.U.V. that he bought two years ago with 39,000 miles on it. He tends to buy stocks in quality companies that he can hold for a long time. Still, the stock market’s wild swings last week left even Forester confused, shaken, and utterly exhausted.

Monday: Dow -5.6%

Forester, 52, arrived at his office Monday expecting few aftershocks from Standard & Poor’s downgrade of U.S. debt. “I didn’t think it would be that big of a deal,” he says. And for a while he was right. Stocks recovered a little soon after the open. “Then I was real wrong,” he says. The Dow Jones Industrial Index finished Monday down 5.6%, its worst decline since the financial crisis.

Forester has long believed the U.S. is at a crossroads. His investor letters are filled with worry over rising debts in America and Europe. He’s questioned how much the Fed has accomplished with quantitative easing. With Congress gridlocked and interest rates already at zero, he also wonders whether government can do anything for the U.S. economy if it hits the skids.

Since May, Forester has stockpiled cash and purchased index puts in his $160 million fund — both moves that protect the fund during market declines — because of his rising worries. The moves have been right so far. As of Friday, the fund had gained 0.5% in 2011 (compared to the S&P’s 5.5% slump) to beat all but 13 of 1,115 fund rivals, says Morningstar.

But after Monday’s bloodbath, Forester was looking at the index puts and thinking, “Wow, I wish I had a lot more of these things.”

Tuesday: Dow +4%

He slept horribly Monday. On Tuesday he drove his usual 10 minutes into work listening to CNBC on satellite radio. Stock futures indicated that the market was coming back. He felt a little relief. But when stocks collapsed after a Fed announcement later that afternoon, he was paralyzed.

“Is it 1987, when everything comes back over time, or is it 2008, when it’s just the beginning?” Forester was thinking. He thought back to a rumor earlier in the week that the big French bank Société Générale was going under. “That is 2008-esque,” he says.

For all his worries, Forester had a nagging feeling Tuesday that he needed to act. He was turning bullish. Stocks were down 20% from their highs during 2011 and the U.S. economic news hadn’t changed too much. He starting reducing the index puts and buying more shares of the companies in his fund. After a big afternoon run-up, Forester thought everything might be back on track. Both the Dow Jones Industrial Average and S&P 500 index had gained nearly 5% on the day.

Wednesday: Dow -4.6%

He slept better Tuesday night and arrived Wednesday to crazy numbers on his Bloomberg screens. The overnight futures on the S&P 500 index collapsed from 1170 to 1077, an 8% swing. “It just looked like the world was coming to….” Forester stops himself before finishing. “Well I shouldn’t say that, sorry. But I started to think, maybe I’m just wrong.”

In just a couple hours he went from bullish to insecure. Stocks crashed out of the gate Wednesday before rising by late morning. By then Forester had steeled himself into buy mode again. He reduced the index puts again and added nearly $10 million of shares across nearly his entire portfolio, which includes top names Chevron (CVX), Marathon Oil (MRO), Altria (MO), The Travelers Companies (TRV), and Microsoft (MSFT). He didn’t have time to pick favorites.

After running up most of Wednesday afternoon, stocks crashed again late to finish down 4.6% on the day. Forester was miffed. “Maybe I’m missing something here,” he thought. “Because the market is really acting funny. You don’t get these large swings in markets unless you’re in a 2008 environment.”

By the end of Wednesday, Forester was spent. He had been barking orders at his two analysts for two straight days. The S&P had whipsawed by more than 4% every day that week. He had been trying for three weeks to take a vacation to Green Lake, Wisc., with his family.

Deep down Forester thought he had made the right moves. He bought stocks Tuesday and Wednesday after they had fallen about 20% from their year highs. He knew the U.S. economic news hadn’t changed as dramatically as the stock market seemed to indicate. So he went home and tried to get some rest. He finally got a good night’s sleep.

Thursday: Dow +4%

When stocks opened higher Thursday and kept climbing, Forester started smiling. The fund still has about 15% of its assets in cash, so he isn’t making an all-in bet on stocks. And he still owns index puts to protect the fund during future falls. But Forester feels like he accomplished the fund’s objective last week: capture 30% of the market downside, and 60% of the upside. “In order to do that you have to add to your exposure somewhere near the bottom,” he says. “But it’s scary down here.” He thinks his high-quality companies will hold up well during tough times ahead.

Once the S&P 500 passed Tuesday’s high during trading on Thursday, Forester thought things would get better. For now, they have. After rising on Friday, stocks are up again Monday.

Forester is finally thinking he might be able to get away for a couple days of vacation. And not that he much cares, but his fund’s relatively small 3.6% decline the past month is better than every single one of its 1,152 competitors.