Michael Sandler

Clipper Fund

by Marla Brill
MFI Publisher

It’s easy for a mutual fund manager to look smart these days if his portfolio contains shares of Philip Morris, which have risen like a smoke signal over the last year.

But think back to late 1999, when the company’s tobacco litigation woes spawned a media circus and market nightmare. By the end of December, Philip Morris stock would be down 54 percent for the year. It was one reason that Clipper Fund finished 1999 with a 2 percent loss, at a time when the S&P 500 Index and technology funds were zooming. Even many of Clipper’s peers in the large cap value group, though straggling behind growth funds, did better.

As investors who had stuck with the stock for years decided enough was enough and bailed out, Michael Sandler, co-manager of the Clipper Fund, picked up some more. By the end of the year, the stock accounted for 7.11 percent of assets. In Clipper’s annual letter to shareholder in December 1999, Sandler and his co-managers felt compelled to justify the presence of what they called "our most controversial stock.."

"As an operating business, Philip Morris is well managed, remarkably profitable and cash generating," it read. "About $3 billion of that cash was used to repurchase its own stock last year. As a stock, it is statistically one of the cheapest available with a price/earnings ratio of seven times and a yield of over 8 percent." As for litigation concerns, the letter noted that appeal procedures ‘will reach far into the new millennium" and that "a massive legal judgement is unlikely to be allowed to shut down an entire industry which serves 45 million customers and provides over $27 billion in annual government revenue."

"A lot of people I knew, even a few who work with me, didn’t believe those arguments were enough to make investors overlook the litigation threat," says Sandler. "A lot of them have changed their minds."

"Stick to your guns," the mantra for true value investors, applies in spades to Sandler and Clipper co-managers James Gipson, Bruce Veaco, and Peter Quinn. As other value funds edged into growthier stocks in the late 1990s, and said it was appropriate to do so to change with the times, Clipper’s managers kept loading up on market castoffs like Philip Morris. That faithful tenacity looked more like sheer stubbornness from 1996 through 1999, when the fund failed to keep pace with the S&P 500 Index..

But shareholders who stuck things out are probably glad they did. Last year, the fund scored a total return of 37.4 percent, as the S&P 500 sank into negative territory. As of March 9, Clipper was up 3 percent year-to-date, compared to a drop of 6.4 percent for the index.

Heel-dragging in strong bull markets, as well as solid returns in sideways and down markets, is a fairly recognizable pattern in a true value fund. In Clipper’s case, Sandler and his team use a deep value strategy that centers around what a rational private buyer would pay for a similar business. If a stock is selling for at least 30 percent less than this "intrinsic" value," which they calculate with their own valuation models, it piques their interest. The focus is on dominant companies generating excess cash flow that are out of favor with investors.

Examining public companies though a private prism comes naturally to Clipper’s management team, most of whom cut their teeth in private industry before joining Pacific Financial Research, which Gipson founded in 1980. Sandler’s hard-to-place accent is a product of growing up in South Africa, where he lived until he moved to the United States to attend the University of Iowa in 1974. He went on to get a law degree there, and joined International Harvester in 1981 as a "manager of asset redeployment"—the company’s euphemistic title for the person charged with liquidating the company’s assets. "Eventually," he says, "I liquidated myself out of a job."

But not before he learned about how to value a company from the inside out, which was one reason James Gipson invited him to join his fledgling firm in 1984. Gipson, a former US Navy officer, had worked as a management consultant at McKinsey & Co. and as a portfolio manager for Batterymarch Financial before founding the firm. Gipson and Sandler have co-managed Clipper Fund since its inception in 1984. Bruce Veaco, a certified public accountant who once worked with Price Waterhouse, joined the team in 1986. Peter Quinn came to Pacific Financial Research in 1987 immediately after getting his MBA.

Next: Few bargains around for Sandler's bargain basement.