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Havens With A Chance For Growth

by Thurman Smith

In the below discussion GROWTH POTENTIAL is a measure of relative up-market performance, RISK EXPOSURE is a measure of relative down-market performance, and ISQ is a measure of reward to risk. The norm for all is 10. Data is as of March 16th.

In times like these one thinks of havens. Other than perfect knowledge as to when to go short and long, the best haven is cash. A money market fund run by a larger firm which might bail out the fund if an issuer defaults, like some west coast utilities lately, is best. 

There are a few ultra low-risk offerings, such as the closed Merger Fund (MERFX) and Gateway (GATEX), which sport almost straight slowly rising 39-week trendlines, but leave one behind in a rising market. A better bet would be funds that can accomplish something in rising markets but are exceptionally resistant in pullbacks. The EFO Investment Skill Quotient is a good filter for this purpose as any risk must be paired with a higher reward (growth potential) reading to earn an ISQ above the norm of 10. 

Below are funds with a reward/risk profile of at least two-to-one that have gained since the March high last year. All happen to be tax efficient. Not surprisingly, value dominates. Over the 8.4 years of their existence the Vanguard Value Index Fund has returned 15.4% annualized while the higher-priced Vanguard Growth Index Fund has returned 13.6%. 

Boston Small Cap Value II (BSCPX) led this group during this period, when the Vanguard Value Index was flat. Over its 2.7 years it has delivered an annualized total return of 13% while the Russell 2000 small cap universe was returned 1%. The fund follows the management firm's philosophy that emphasizes value, focused internal research and risk aversion. Firms must have sound business fundamentals and positive momentum. A small asset base of only $2.4 million is positive. Services, financial and others, are half the portfolio; technology is only 5%. 

UAM Clipper Focus (CLPRX) is a fully-invested version of the original Clipper Fund. Both funds can severely lag when growth is ascendant, but for patient investors they have paid off over the long run. The approach requires discovering the intrinsic value of a firm using rigorous cash flow analysis and modeling. The team doesn't want to pay more than 70% of that value. Both funds have shot up recently, owing to some good picks such as downtrodden Philip Morris, Freddie Mac and some REITs. There are four managers, two of who have been with the flagship version since 1984. The name correctly suggests more concentration than at the average stock fund, with 60% of assets in the top ten of its thirty-one issues. Since inception in September, 1998, Clipper Focus has returned 3.5% more a year on average than Clipper. And that return (22.3% annualized) was three times that of the market. Just over half of assets are in mid-cap firms with the rest in large- or jumbo-caps, plus one small-cap holding, so we'll tag it as an all-cap vehicle. 

The team has no hesitation playing sector favorites: lately this has been financial services, a third of the portfolio. Their sell discipline sometimes means forgoing continued gains, such as when they sold Nike last year after a good gain but well before the top was reached. One would buy this fund based on the high ranking of its older sibling in the large value group over periods of three-years or more and an understanding that it might get left behind for a year or two in an earnings-momentum market, and its utility in portfolio volatility control. For Schwab investors it has the advantage over Clipper of being available NTF. 

It looks like Oakmark (OAKMX) will be useful yet again, this time for value investors who feel more comfortable with fifty issues as opposed to the twenty in Oakmark Select. Technology counts for only 9% of assets, but this is 9% more than Sanborn had. Large- and jumbo-cap stocks are 36% of assets, where at Select they are only 26%. But If I were to have only one Nygren fund I'd make it Select, which he describes as "my best picks."

Mid-cap Oakmark Select (OAKLX) offers one the best all-weather vehicles as there is a requirement for potential growth for any stock to be included. As a concentrated fund (twenty issues) shareholders
have to realize that there will be times where its firms are out of favor and the fund will not keep up with the market. Bill Nygren first figures out what the private market value of the firm is to a rational buyer. If the stock price is less than 60% of this value he considers buying. This approach has resulted in some profitable takeovers such as McDonald Douglas, Sterling Commerce and Times Mirror.

American Century Small Cap Value (ASVIX) did not really start to distinguish itself from its peers until a year ago. Owing to a strong twelve months it has overtaken the peer average by five percentage
points, annualized, since inception in the last quarter of 1998. This looks like a case where more time in the lead would be required for 
a buy.

More consistency prevails at Wasatch Small Cap Value (WMCVX) where Robert Gardiner and Jim Larkins pick up fast-growing firms that have stumbled and tiny names little known to their competition. Health and service are the largest sectors. As with most micro-cap offerings the number of issues, 89, is larger than for most diversified funds. Small Cap Value is really a micro-cap fund and might be useful paired with a small-cap fund with a median market cap at the other end of the range like Westport Small Cap or Buffalo Small Cap. 

Weitz Value (WVALX) has bested its mid-cap value peers in each year starting with 1997, though for 2000 its 19.6% return was just barely above that of its class. The numbers look good over any three-year period, but they mask a tendency to load up on a couple of sectors where Wally Weitz sees the most value. For several years this has meant media and telecommunications, especially cable, and mortgage banking. At times this concentration has caused the fund to lag its peers enough to want to sell. That 56% of assets are in the top-ten stocks and its hefty net assets of $2.2 billion suggest smaller and more diversified mid-cap value choices might be better bets.

Ameristock (AMSTX) is delightfully boring. Nicholas Gerber has been running this low-risk large-cap offering for five and a half years, delivering an annualized total return almost twice that of the market with a risk level half that of the market. In periods when earnings momentum is in favor, like 1999, Ameristock will look pallid. But considered as a core holding in the large-cap arena with low tax-impact, low turnover and reasonable expense ratio it becomes more attractive. Thirty-nine percent of the portfolio is in jumbo-caps, thus the median market cap of $49 billion. Ameristock might be useful paired with a large-cap fund that favored the smaller end of the range like PBHG Large Cap Value or Gabelli Blue Chip Value.

Copyright © 2001 Thurman Smith. All rights reserved. Thurman Smith is an asset manager in Boston specializing in growth funds and editor of Equity Fund Outlook, a monthly subscription newsletter that rates over 250 growth funds on the basis of management skill. Equity Fund Outlook is highly rated by the Hulbert Financial Digest. For information about Equity Fund Outlook and a low-cost trial subscription visit www.efoutlook.com, call 800-982-0055, or send a post card to E.F.O., P.O. Box 76-B, Boston, MA 02117.

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