Steve Hayward and William Garrison

Liberty Tax-Managed Aggressive Growth Fund

by Nancy Opiela
Senior MFI Correspondent

As the NASDAQ Composite Index continues to tumble with Internet, networking, and computer software shares taking it on the chin, many mutual fund managers have been pulling out of technology. Not so for Steve D. Hayward and William M. Garrison, managers of Liberty Funds Distributor's Tax-Managed Aggressive Growth fund.

Although the NASDAQ is within striking distance of this spring's lows, Hayward and Garrison stand by their 46% weighting in technology. Said Garrison, "At the end of the day, we still believe the technology sector represents the greatest area of growth in the economy today, and we expect to use periods of weakness such as the current environment to add to our highest quality technology names."

That conviction has produced mixed results so far for holdings like Flextronics International, a provider of electronics manufacturing services. Bought at an average cost of $82, the stock has been hit by the technology dive and now sells for $62 a share. However, the managers remain upbeat.

Said Hayward, "The Motorolas of the world cannot keep up with change in product and manufacturing efficiencies. Currently, 10% of all electronics manufacturing is outsourced and we think that number will continue to accelerate. Flextronics is one of the major leaders in this area and benefits from having dealt with companies like Cisco who have set the standards for outsourcing manufacturing. Flextronics is aligned with some of the fastest growing companies and product categories in electronics and the opportunity is there for them to garner more business in the United States, Europe and, ultimately, in Japan company. We think they can put up top to bottom line growth of close to 30% for the foreseeable future."

Launched in August, the fund is Liberty's fourth tax-managed equity fund and one of the first such funds to specialize in mid-cap stocks. Like many fund managers, Hayward and Garrison seek to invest in companies with long-term growth prospects. The difference here is that they also actively seek to reduce taxable distributions to shareholders through a variety of strategies. These include maintaining longer holding periods, minimizing unnecessary portfolio turnover (except when portfolio turnover may actually reduce shareholder exposure to taxes), purchasing low-dividend paying stocks, and offsetting gains with losses.

Hayward and Garrison's mid-cap universe is made up of companies with market caps under $10.5 billion, but the current average market cap of the portfolio is just $3.9 billion.

"We will not be running a significant barbell portfolio where we have the Intels of the world and then an equal percentage of tiny names that nobody has ever heard of," said Hayward. "We are concentrating on the mid-cap arena and will look at the S&P 400 growth as more or less of a guide and direction of what the parameters of our market-cap should be."

With the market approaching two years of relative outperformance for small- and mid-cap arena versus large-caps, the managers say the timing is right for the fund's launch. "I think investors are looking to diversify their portfolios and move out of large caps," said Garrison. "This is a wonderful time for small and mid-sized companies to participate in the technological revolution. What's more, the state of the financial markets has enabled lot of companies to go from ground zero to critical mass in a relatively short amount of time. We are looking for those situations."

The managers acknowledge that it's often riskier to invest in small or mid-sized companies due to their limited product lines and financial resources. Additionally, stocks of small and mid-sized companies may trade less frequently, in smaller volumes and fluctuate more sharply in price than stocks of larger companies. But market and stock volatility also present opportunities for Hayward and Garrison.

Said Garrison, "We recognize that in the small- to mid-cap space there will be more volatility and more times when we will be tempted to take profits. And there are times when we will take those profits. However, we will also use those periods of weakness in certain stocks to offset gains we might have taken.

"We'll also use periods of weakness for one holding as an opportunity to look at alternative investments. If we missed on the timing of a particular bet on a semiconductor company and our position is under water, it's much easier in the mid-cap arena to find another investment in the sector to add to the portfolio so we can go ahead and take the loss on the first stock. The idea is to realize the loss on the weak stock to offset gains and find another stock in the sector so we can maintain our exposure to the group."

Currently, the portfolio holds 55 stocks. Qualities Hayward and Garrison look for in a stock include high top and bottom line growth; unique products or services to differentiate the company; the capability to generate well above average return on investment; and significant management involvement.

"We want more than for management to own 1 to 2% of the company," said Garrison. "We are looking for managements that own a significant amount of the company and we like to invest with entrepreneurs early on."

Garrison notes that the fund will invest in early stage companies that have not yet reached levels of profitability. One such name is Matrix One, a provider of collaborative software to the manufacturing industry. "Their platform allows manufacturing companies to collaborate with suppliers, customers, engineering and sales and marketing staffs," said Garrison. "The stock went pubic in March and the most recent quarter had $25 million of revenues. From an earnings perspective, they are just beginning to turn a profit. However, this is a company that is investing in its growth and we expect to see a significant increase in earnings and profitability."

Another significant commitment is 12% in healthcare, a percentage the pair would like to take a little higher. Said Garrison, "We think healthcare will continue to be a growth driver in the market in the years ahead as demographics and scientific advancements in areas such as biotechnology create new growth opportunities. At the margin, I could see some rotation from technology into healthcare in the months ahead as we look to deploy new cash received in the fund."

Two other areas that benefited the fund in recent months are financials (10%) and energy (6.5%). A financial pick the fund has held from the start is MGIC Investment, a provider of mortgage insurance. The company has produced earnings in the 15 to 20% category, which is at the lower end of the pair's target, but the stock became very attractive when the managers were able to pick it up at a 12 to 13 multiple.

The fund has no direct international exposure. "We are trying to stay with what we know best," said Hayward. "Investing in U.S. companies makes it that much easier to meet with managements and that suits our style. It's not our intention to invest in places like Southeast Asia."

It's important to note that the fund does not promise a tax-free situation for investors and expects to generate and distribute capital gains from time to time due to market conditions, shareholder redemptions, etc. Said Garrison, "We focus on having the lowest distribution we can over time and, at a minimum, pushing everything out to long-term gains."

How long do Hayward and Garrison plan to hold stocks? Said Hayward, "We're investing for the long-term. The immediate time horizon is one year, but if a stock achieves some of our price targets in a shorter period of time, we'll re-appraise it to determine whether the stock could fall 50% while we're waiting. It's our hope, however, that several names will be in the portfolio for many years. We're looking for companies we can grow with."

Click here for other information about the managers and their fund.