Everybody loves getting in on a secret. It doesn't matter what it's about, whether it's the designer of the clothes some celebrity's baby wore yesterday or the identity of the leaker in the Watergate scandal. While some secrets cost you only the price of a grocery-store tabloid, some people will try to collect quite a bit more.

Consider how much you would pay to learn the secrets of successful investing. Many well-known financial gurus have written books that try to explain their winning recommendations; several, such as Peter Lynch's One Up on Wall Street, have become best-sellers. Even now, many fund managers define their aspirations for success by seeking to become the next Peter Lynch or Bruce Berkowitz.

It turns out, however, that the secret of how successful fund managers pick investments isn't much of a secret at all. You don't have to buy a book or a magazine to find it. In fact, it doesn't take a lot of effort to find out all sorts of things about how the best fund managers are investing.

The worst-kept secrets of successful fund managers
Sounds like a good book title, doesn't it? In truth, fund managers aren't allowed to keep their investment choices secret for long, because mutual funds are required to fully disclose their holdings. The Investment Company Act of 1940, which governs mutual funds, requires funds to disclose several types of information to fund shareholders at least twice a year, including financial statements of income and capital flows, fees charged by management, and lists of securities held. The SEC has considered requiring more frequent disclosure, and many funds voluntarily release information on a more frequent basis.

This means that if you identify a fund manager whose style you like, and whose results have been good, you can look at what investments have contributed the most to the manager's success. There are a few different ways of doing so.

Analyzing fund holdings
Some mutual fund managers choose to take large positions in a relatively small number of individual stocks. If the fund performs well, it's usually because those large positions do well. So by looking at the largest holdings in a particular fund, you often identify individual stocks that have performed well. For instance, in looking at the market-beating performance of the Fairholme Fund , the top 10 holdings constitute almost 65% of the entire fund. Focusing on holdings like Pfizer (NYSE: PFE), Berkshire Hathaway (NYSE: BRK-A) (NYSE: BRK-B), and Echostar (Nasdaq: SATS), you can see that each has managed to limit its losses this year, which helped contribute to the fund's overall performance.

Not all of a fund's top holdings have to be winners for the fund to perform well. For instance, a look at T. Rowe Price Health Sciences Fund shows that while investments in Genentech (NYSE: DNA) and Cephalon (Nasdaq: CEPH) have done well, the fund's shares of BioMarin Pharmaceutical (Nasdaq: BMRN) put the brakes on fund performance during 2008. Sometimes, the best-performing choices won't even be among the top holdings.

If you're willing to do a little more research, you can compare quarters to see what changes a fund manager is making in the fund's holdings. If a company drops off the holdings list, then you know that the manager has lost confidence in that company. Similarly, if a new company appears, or holdings in an existing company increase dramatically, then the manager believes that company will do well. Continued...