Anything but a Hit-and-Miss Approach


By James Anderson Out on the golf course a few years ago, Dan Bandi got a lesson on how focus can do wonders for performance. Bandi, the 36-year-old lead manager of the Armada Small Cap Value Fund (AMRIX), was playing with his golfing instructor, an 80-year-old fellow who was hobbling about on a lame foot. Bandi was confident. "I could send the ball a good 250 yards, although not in any particular direction," he recalls, "My instructor could muster no more than 150 yards per shot, but always straight down the fairway." By the time they reached the clubhouse, the old man's score was close to par; Bandi finished with a score about 30 over par.

Applied to management of a mutual fund, the moral of the golfing episode is simple: Shot by shot, near-term results can be exciting, but they don't beat the steady numbers that a focused, straight-ahead portfolio delivers over time -- over all 18 holes, if you will. By keeping your focus on the long term, you may not dazzle the world in any given month or year, but you'll still come out a winner.

It easy to see how Bandi's tutorial on the green has paid off. The Armada Small Cap Value Fund, which he took over in 1999, ranks among the best portfolios in its category. It's a member of BusinessWeek's A list of high-return, low-risk equity funds, and it rates five stars -- top marks -- from mutual-fund researcher Morningstar. Its 30.5% total return in 2000 was some 46% percentage points higher than the S&P 500. And 3-year and 5-year average annual returns of 16.0% and 17.4%, respectively, put Bandi's portfolio within, or very close to, the top decile of all small-cap value funds.

THREE-PART YARDSTICK. Bandi credits the fund's results to the tests he and a trio of managers put stocks through. They start by carving out a chunk of the market limited to companies with capitalizations of between $100 million and $2 billion. At the same time they also narrow their scope to stocks that are liquid enough to generate a daily trading volume of $750,000 or more. That way, the fund won't bid up a stock's price when it enters a position or sabotage its sale of shares when it exits.

Next, Bandi puts several value criteria to work. He ranks shares that have passed his first hurdles by three ratios: price-to-sales, price-to-cash flow, and price-to-book. He casts off the top half of companies according to each ranking and then starts to work on a focused group of say, 250 stocks.

The fund manager calls the final step the "touchy-feely" part of portfolio building. What this entails is digging for news that might trigger a marked increase in the share price of any one of the 250 remaining candidates. In some cases, he'll settle for news such as a merger or pending deal. More often than not, however, he's keen on more concrete evidence, such as positive earnings surprises or a series of upward earnings-estimate revisions by analysts who follow a company.

ON THE BRIGHTER SIDE. "We're looking for good value and good news, and no matter how cheap a stock gets, it needs a change in investor sentiment to rebound," he says. In the end, Bandi has assembled a roster of 103 positions that, on average, mirror the Russell 2000 Value index of small-cap shares. The average stock in Armada's portfolio, for instance, is priced 0.84 times sales, carries a 1.79% ratio of share price to book value, and fetches 8.09 times cash flow. The Russell 2000 Value index averages 0.8 price to sales, 1.63 price to book, and 8.59 price to cash flow.

While Bandi likes to run an actively managed portfolio and is likely to turn over 100% of his portfolio over the course of a year, he's keen to keep close tabs on the index, if only to avoid overemphasizing one or two sectors. "Too often it seems that a small-cap fund is steeped in tech stocks, so investors enter looking for diversification and end up with a sector fund, " he points out. "Under those circumstances, one bet might end sinking the whole year."

Armada's bylaws keep that in check. Bandi is barred from planting more than 3% of the fund's assets in any one name. As sectors go, the rules are strict, too. Small Cap Value's portfolio can't invest more than 50% of its assets in any one industry group. Moreover, Bandi says the fund can't stray more than 10 percentage points from any sector weightings of the Russell 2000.

A QUESTION OF BALANCE. There's a benefit to that kind of discipline. Armada's fund has thrived in a year when the S&P 500 has sunk, generating a total return of 11.1% so far in 2001, compared to -6.8% for the large-cap index. Morningstar analyst Alan Papier says a key statistic -- the fund's R-squared, the measure of how closely it tracks the S&P 500 -- shows Armada Small Cap Value to be a very good counterbalance for investors who are heavily weighted in large-cap holdings. While an R-squared of 100 would indicate that the fund was in lock-step with the 500, Armada's score is a lowly 38, a sign that it's bound to do well when the index is foundering.

"This fund is simply a very good way to diversify a portfolio," says Papier. "The fund manager has been stable -- he has stayed right in his category and has kept volatility to a minimum." As of June 1, the fund manager's largest position was in financial stocks, including banks Dime Community Bancshares (DCOM) and Astoria Financial (ASFC), which altogether made up 17.1% of his portfolio. Armada Small Cap Value has also been building something of a toehold in tech of late, although the fund's position is still rather modest compared to growth portfolios. At the end of May, Bandi says the fund had 9.6% of its assets in technology shares, compared to 6.4% for the Russell 2000.

Unova Inc. (UNA), a Los Angeles company that makes automated tools used in manufacturing and wireless barcode scanning products, is a newcomer to the fund. Mired in debt and socked by a slowing economy, Unova made Bandi's radar after sinking to a share price of just 50% of its book value and a mere 0.18 times sales.

Bandi has spied catalysts to set Unova back on track. First, the company has whittled down debt. Second, reasons Bandi, an economic recovery this year could prove a boon to the Unova's barcode operations. The portfolio manager started buying Unova shares this month at an average cost of $5.70 a share. He thinks the stock, which closed June 29 at $6.88, a share could double in 12 months.

GREAT EXPECTATIONS. Bandi also recently snapped up shares of the Phoenix Companies (PNX), a life insurance and money-management company that went public in June, 2000. Bandi says the company compares favorably to Mutual of New York (MNY), another insurer that fetches more lucrative valuations. Mutual of New York shares have a price-to-book value of 0.91 and a multiple of 15.5 times projected earnings. Phoenix, for its part, gets 0.80 of its book value and a p/e of just 13.5. Bandi says the market should soon notice the disparity.

He also believes Phoenix, with a solid annuity and money-management operation, will be rewarded for a steadier, more dependable profit stream than Mutual of New York, which has substantial exposure to the venture-capital market. Bandi, who has paid an average $17.50 a share for his stake, feels Phoenix could reach $25 to $30 a share over the next year. On June 29, Phoenix closed at $18.60.

Bandi anticipates a recovery for the second half of 2001, and has picked up shares in cyclical industries and tech, where he thinks added exposure will benefit the fund. Bigger positions in semiconductor stocks and defense and aerospace don't spell a makeover, however. "We were really busy in the first three or four months of the year, when we saw some good buys," he reports. "Now that we're through, we're happy with our sector weights and plan to sit around and wait for our ideas to take off." Anderson teaches journalism at the City University of New York. Follow his twice-monthly Mutual Fund Maven column, only on BW Online


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