June 23, 1998

STREET WISE by Amey Stone


Even the greenest investors know they should review the fundamentals of a stock -- including past performance, earnings-growth rate, and price-earnings ratio -- before investing. But too few ever check the fundamentals of their overall portfolio, says Harindra de Silva, managing director of Analytic/TSA Global Asset Management in Los Angeles, which manages $1.1 billion, mostly in institutional accounts. "Everyone wants to talk about individual stocks," he says. "But not that many stop to ask: 'What does my entire portfolio look like?'"

De Silva not only asks that question but he makes it the driving force of his small and highly successful mutual fund. Armed with a PhD in finance, he has created a complex computer program that mixes together large-cap stocks to create a portfolio with exactly the characteristics he's looking for. His goal is for Analytic Enhanced Equity (ANEEX) to outperform the S&P 500 with slightly less volatility than the index.

So far, all has gone as planned. Enhanced Equity is in the top 3% of all funds in Morningstar's large-cap value category over the past three years. It has returned an average of 30% annually over that time, beating the S&P by about 1% a year. This year, it has done even better relative to the index: Enhanced Equity is up 21% in 1998, while the S&P has returned 14%.

Top holdings in the $15 million fund include General Electric (GE) and Microsoft (MSFT), but DeSilva admits that he doesn't really know why those stocks are in the top spots. This is heresy to many successful portfolio managers who spend their time visiting companies, interviewing management, and poring over balance sheets. In contrast, DeSilva cares only that when you average all the stocks together, the portfolio has certain characteristics, such as a low price-earnings ratio, high earnings growth, and recent stock-price momentum.

It would be virtually impossible to construct a portfolio by hunting down individual stocks that meet DeSilva's criteria. But by mixing stocks with different strengths and weaknesses, the overall portfolio can have the characteristics he's looking for, creating, in effect, a "Super Stock," says De Silva. Enhanced Equity actually contains about 75 stocks that have been run through a portfolio "optimizer" that factors 70 different screening criteria.

Unclear how this works? To illustrate how to put together a Super Stock portfolio, DeSilva simplified the process down to just three stocks and three measures. Consider how these three very different stocks would combine: Dow Chemical (DOW) has a low p-e, strong earnings growth, but poor price momentum. Home Depot (HD) has a high p-e, even stronger growth in EPS, and excellent recent stock performance (which is a negative to DeSilva, since the stock may not have much further to run). Then there's Texaco (TX), which has a low p-e, high earnings growth, but poor recent performance.

When you combine all three stocks (weighting Home Depot and Texaco 40% each and Dow 20%), the portfolio has a p-e of 17 and earnings growth of 25%. That's a far sight better than the S&P's average p-e of 27 and earnings growth of 14%.

DeSilva runs the portfolio through the optimizer monthly, generating portfolio turnover of nearly 200% annually. This requires a powerful computer and talent for mathematics, but that doesn't mean investors with only a handful of stocks can't analyze their portfolio by doing some quick math "on the back of an envelope," says DeSilva.

Of course, the easiest way to try this strategy is to buy DeSilva's fund. Interested investors should move quickly, though. The fund will be sold with a sales charge after July 27 when it will join the PBHG Advisor fund family. (Both Analytic/TSA and PBHG are owned by United Asset Management (UAM), which owns a total of 53 investment management firms.)

"Given the fact that these strategies are fairly complicated, the idea is that brokers will be more successful selling the funds," says DeSilva. But investors who have the smarts to understand the Super Stock strategy, and who buy in before the end of July, will be grandfathered in as no-load investors and be able to transfer among all PBHG Advisor funds without the extra fee.

Amey Stone is associate editor of Business Week Online.

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