Markets & Finance

There's More Than One Way...


Thomas DiBella of Aetna Small Company Fund/I (AESGX), has several ways of selecting stocks for this small-cap blend portfolio. Some are found through a quantitative model that emphasizes earnings momentum. Some are found through a set of screens that can identify more value-oriented companies from cash flow and the balance sheet. Still, others are found though research that does not always result from the findings of the model or screen.

The approach has paid off in the long term. For the three years ended February 28, Aetna Small Company Fund returned an annualized 12.6%, versus an average 4.6% for its small-cap blend stock fund peers. For the five years ended February 28, the fund was up an annualized 14.4%, versus 10.4% for its peers. Aetna Small Company is classified as a Select Fund by Standard & Poor's.

However, Aetna Small Company Fund underperformed its peers for the trailing 12 months ending in Februrary -- its worst period ever -- losing 25.5%, versus a loss of 3.9% for small-cap blend funds. The reason: exposure to tech and biotech during the March-May 2000 time period, when the fund was tilted more toward growth. Year to date as of the end of February, however, the fund is edging out its peers.

The fund's stock allocation currently consists of about 65% value and 35% growth. Its top holdings include Sylvan Learning Systems (SLVN), Independence Community Bank (ICBC), and Agrium Inc. (AGU). The fund recently purchased wireless phone maker Audiovox (VOXX).

Standard & Poor's recently spoke with DiBella about his investing philosophy, and the stocks and sectors he likes now. Edited excerpts of the conversation follow.

Q: What is interesting about your investment process?

A: It is a two-pronged process. One part is more quantitatively driven. What are our best horses to buy here? Which companies have the best momentum? This is essentially an earnings momentum model that we are using, with a few other factors thrown in. It usually yields most of our growth ideas, but not all of them. We can actually find some value ideas using the model too, particularly when we have companies or industries with a cyclical base.

Q: What is the second way that you have to identify stocks?

A: It is more of a classical, fundamental-research oriented kind of approach.

We have devised a series of screens -- very simple screens -- designed to find investment opportunities where the model does not look, namely the balance sheet and the flow of funds.

This is a little bit more of a "let's look at the value of the business and the cash flows and see if there are maybe some hidden assets."

Q: Must these two processes coincide in some way or both point in positive directions for a buy?

A: No. They do not have to coincide. If we have a stock that looks good on the model, and we follow it up with due diligence research and determine that the strong momentum the model is pointing out is sustainable, we buy it. It might not look good on an asset basis or a cash flow

basis.

Q: The portfolio is classified as a small-cap blend fund by Standard & Poor's. Do you have a bias toward growth or value?

A: We don't really have a bias toward either. We balance the two. We never want to be totally growth or totally value. We like it 50/50 ideally, but it is not a cause for concern if we don't get this. It can be 60/40 or 40/60. Right now, we are roughly 65% value and 35% growth. We don't do a kind of top-down analysis, we just get there one stock at a time.

Q: If you are finding a number of companies in a certain sector, must you limit your sector weights so as not to become overweight in any one area?

A: We use guidelines. We try not to let our investment in any sector become more than two times the index weight in that sector. If health care were 10% in the (Russell 2000)

index, for example, we would not allow our investment to get higher than 20%. We don't want to be totally out of a sector either. Whereas we don't want to make a major bet on a sector, we certainly don't want to make a major bet against a sector.

Q: What are your largest sectors and top holdings as of the end of February?

A: Financial services is 18.1%, consumer discretionary is 17.8%, health care, 16.2%, technology, 11.6%, and other energy, 7.6%.

The top holdings are Sylvan Learning Systems, Pittston Co. (PZB), Independence Community Bank, Agrium Inc., and Pacific Century Financial (BOH).

Q: Could explain why one of your top holdings is attractive, and tell me how you got there?

A: Sylvan Learning Systems provides educational services. It is a tutoring and testing company. They are getting more involved with universities. They do a lot of testing with teachers who want to become certified and have courses and tests for this.

Everyone wants to learn English, and they have also had a big hit with English tutoring all over the world. When one of their facilities in China opened, it did five times as much volume

as they thought in the first week.

The company sold some assets when they were trying to restructure. At the time we bought the stock it was at about $11, and the company had $8 a share in cash and no debt. We found it with one of our cash screens. It really did nothing for awhile after we bought it. Maybe it went up to $14 or $15 and then just sat there for three or four months. Recently, it has increased to about $21 dollars a share, so it has been a pretty good holding, as well as a fairly low-risk situation.

Q: Do you have an example of something you have bought recently?

A: Yes. It is actually a tech company, so you hold your breath a little. We just started buying it, and the stock has kind of been moving down.

One of the screens we run on the value side is called the net net screen. What we do is basically take the working capital of the company, minus the debt. If that is more than the

stock price, we take a look. This is basically saying that if you liquidated this company you would have more money than the company is selling at without putting any value on the business or on the management.

The company that we bought recently is called Audiovox. It is probably too early to tell if it is going to work, and it is in one of the crummiest areas you can go into right now, technology. However, they design wireless phones, and they have a product that looks kind of attractive, which is due out at the end of the summer. They are going to combine a Palm with a phone, basically. We think the risk/reward is pretty good. Also, it is very cheap. You are basically getting the business for nothing, and you actually could pull about $10-$20 million out of the business after you paid off all their liabilities and use their

working capital.

Q: Have your stock selections all come from running your model or screens?

A: No. Agrium is a top holding, and it is kind of a unique story. It wasn't really found using the model, nor screens.

Q: What do you find interesting about the company?

A: They are a nitrogen-based fertilizer company. We bought them somewhat as a play on natural gas prices, which have taken off. The cost to product nitrogen fertilizer has skyrocketed. A couple of weeks ago about 40% of the production closed down. In fact, some of the guys producing the fertilizer sold their natural gas, because they had a profit in it, and stopped making the fertilizer. The price they needed per ton of fertilizer was $350 a ton. They were only getting $250 a ton. In other words, they were losing money.

Agrium, however, was in a unique situation. They had 50% of their capacity for natural gas tied into long-term contracts in Argentina and in Alaska. They secured this for about $1.50 per Mcf, and gas has gone a lot higher. We think they will make money if gas prices continue to go up. In addition, we are now wondering if there might be a shortage of nitrogen fertilizer this spring.

Q: Financial services is your highest overall sector weight? What is the reasoning?

A: It is the largest sector in the index, the Russell 2000. I think over the seven years we have run the fund it is still relatively high. I think we are still probably underweight a

little bit there. We have been lower. It is not usually an area we look to make a lot of points. The stocks don't move that much.

Q: When do you start to think about selling?

A: As a general guideline, we start looking at anything that declines 25% from where we bought it. I am not saying that we sell it, but we look at it. We ask ourselves if we missed anything. Or maybe it was just the wrong timing with the market. Do we still like this company, or do we want to add to it? Do we want to sell it and get out?

Any stock that is up 50% from where we bought it we also review. We don't sell a lot of them, but we do review them. Maybe 50% is a pretty good gain, and the stock is at our target

price. From Standard & Poor's FundAdvisor


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