Markets & Finance

All Growth, All the Time


The Turner Mid Cap Growth Fund (TMGFX) tilts toward earnings momentum, investing exclusively in growth stocks, regardless of the nature of the overall market. That concentration magnifies its gains when the market is up -- and its losses when the market sinks.

Christopher McHugh, lead manager of the fund, has a special expertise in technology and the producer durables sectors. Robert Turner and William McVail are the co-managers.

Due to the fund's long-term solid performance and its adherence to a consistent management style, Turner Mid Cap Growth has been designated as a "Select Fund" by Standard & Poor's.

Palash Ghosh of Standard & Poor's FundAdvisor recently spoke with McHugh about about the fund's investing strategy, top holdings and recent portfolio moves. Edited excerpts of their conversation follow:

Q: Describe your investment process. What kind of stocks do you look for?

A: We seek out mid-cap stocks trading at reasonable valuations that we believe will exhibit strong earnings growth potential -- we think earnings expectations drive stock prices. Our investment process involves a bottom-up strategy that combines quantitative and qualitative analysis. It comprises three major steps: First, we have a proprietary computer model which we use to screen stocks according to various earnings-growth and valuation factors. Companies are then ranked from the first percentile (most attractive) to the 100th percentile (least attractive). Those which rank in the top 35% qualify for further consideration.

Then we use fundamental analysis to determine whether the companies will exceed, meet, or fall short of analysts' consensus earnings expectations.

Finally, we use technical analysis in order to evaluate trends in trading volume and prices of individual stocks. Altogether, stocks that rate favorably according to these three steps may be bought for the fund. Stocks that rank unfavorably either will not be purchased or, if they're already in the portfolio, will be sold.

Our model is dynamic and evolutionary; however, the factors that drive stock price appreciation can vary among different sectors. For example, tech stocks are driven by earnings revisions and earnings surprise; while, with materials & processing companies, we look at such things as price-to-sales ratios and cash flows.

Q: Given the weakness of the markets and the slowing U.S. economy this year and last, have you modified your investment model?

A: For the most part, nothing has changed in our approach; earnings growth remains our primary focus in determining a company's future stock price performance. However, due to the economic downturn we've endured over the last year or so, our quantitative model has placed somewhat greater emphasis on such factors as cash-flow from operations and operating margins (across all industrial sectors).

Q: What is your benchmark?

A: The Russell Mid Cap Growth Index, and we seek to remain sector-neutral -- that is, we try to have our sector allocations match those of the benchmark.

Q: How large is the fund?

A: As of November 14, we had about $705 million in net assets. As of October 31, the portfolio was composed of 117 holdings.

Q: What are your largest sectors?

A: As of September 30: Health care, 31.7%; technology, 19.9%; consumer discretionary, 18.8%, and financial services, 10.6%. These allocations are all very close to those of the benchmark.

Q: What are you largest holdings?

A: As of Oct 31, 2001: Polycom Inc. (PLCM), 2.5%; Verisign Inc. (VRSN), 2.2%; Broadcom Corp. (BRCM), 1.9%; IDEC Pharmaceuticals (IDPH), 1.8%; Best Buy (BBY), 1.7%; Laboratory Corp. (LH), 1.7%; Guidant Corp. (GDT), 1.6%; King Pharmaceuticals (KG), 1.6%; Brocade Communications (BRCD), 1.5%; and Intersil Holding Corp. (ISIL) 1.5%.

Q: After soaring about 125% in 1999, the fund slipped 8% in 2000, while the benchmark dropped 12%. (Through November 13 this year the fund is down 32% and the benchmark is off 24%). Can you comment on the fund's recent performance?

A: We try to be consistent -- we adhere to our sector-neutrality philosophy and our commitment to investing in true growth stocks. Generally, in an upward trending market (like the one we witnessed in 1999), we will do extremely well. In a downward trending market, as we've had in 2000 and 2001, we will be in line or perhaps a few points below the index.

In the last quarter of 2000, technology really fell apart, and that hurt our performance that year. But we did well in the first half of that year, which helped cushion the severe downturn in the second half.

In 2001, virtually all sectors have been hit hard, with technology faring the worst.

Q: What is your view on the technology sector as a whole?

A: We have endured one of the worst information-technology spending environments in many years. No sub-industry within tech has escaped the massive sell-off.

Tech was in an overbuilding phase, an inventory recession is what we're going through now. Generally, the tech sector featured high-multiple stocks in a slowing economic environment, creating excesses in the market. It's taken a long while to flush out all that fat. Earnings estimates plunged to all-time lows.

However, now, we are finally beginning to speak about earnings surprises within the sector. I am now quite bullish on tech and I think we will see a substantial amount of money flow back into tech equities.

Q: What industries within tech are you focusing on now?

A: There are three: storage-area networking, security, and semiconductors.

Within storage area networking, we especially like are Q-Logic (QLGC), Finisar Corp. (FNSR) and Brocade Communications (BRCD) -- these stocks have had tremendous runs in the fourth quarter and we think they will continue to perform well into 2002 and 2003.

We bought our initial positions in Q-Logic and Finisar in the final week of September. We determined that following the terrorist attacks of Sept. 11, there would be a shift and re-prioritization of spending environment issues related to storage-area networking.

As mid-cap firms, Q-Logic, Finisar and Brocade are more involved in the switching technology, they're not selling the hardware like big-cap companies like EMC (EMC) and Hitachi are.

In the security arena, VeriSign has been a core holding for us. Two new names are Internet Security Systems (ISSX) and RSA Security (RSAS). There is an appetite now for increased computer software and Internet network security in both corporate America and the country in general. We are forecasting 20%-25% annual growth in this area.

Semiconductor stocks are strong cyclical plays when the U.S. and global economies recover. In this sector we particularly like the wireless names like Intersil Holdings, Nvidia (NVDA), Globespan (GSPN) and RF Micro Devices (RFMD).

Q: What areas within health care do you like?

A: We've recently added some biotech names -- this is an area where we've kept an under-weight for a long time. We wanted to increase our exposure here because we wanted a more aggressive character to the portfolio. We removed some health services stocks to make room for some biotech names. Within biotech, we've raised our positions in IDEC Pharmaceuticals, Affymetrix (AFFX), Millennium Pharmaceuticals (MLNM) and CV Therapeutics (CVTX). Since biotech is very risky, we selected names with viable products and strong management teams.

On the flip-side we've lowered our exposure to the pharmacy benefit managers, including such names as Express Scripts Inc. (ESRX) and Advanced Paradigm Inc.

Both of these stocks have come under pressure due to the quality of their earnings. In addition, we sold off some generic pharmaceuticals like Watson Pharmaceuticals (WATS), again, due to the quality of their earnings.

Q: Like many tech stocks, Broadcom has plunged in price this year. What do you like about it? Why have you held onto it?

A: We held onto Broadcom because, despite the very difficult environment, they've been able to gain market-share, they are delivering new products, they've made some acquisitions, they have strong cash flow and they have solid business partnerships. Thus, they're well-poised to rebound strong when the economy revives. Although the stock is down for the year, I think it's moved up about 35% in the past few weeks.

Q: Within consumer retail, Best Buy has been a terrific performer this year. Discuss them.

A: Best Buy is an consumer electronics retailer -- they've made the right moves and are well-positioned to grow. They've met their earnings every quarter in 2001, and they've made an acquisition into Canada, providing them with 70 additional existing stores. Best Buy is actually getting a bit rich in price now.

Q: What's your view of retail stocks as a whole?

A: Both the Government and Alan Greenspan know the importance of the consumer sector, which accounts for two-thirds of national GDP growth. The interest rate easings and the stimulus tax package were designed to raise consumer spending and consumer confidence.

I think the stock market is starting to anticipate a recovery --- at this cusp, investors should be not only in small and mid-cap stocks but also in retail stocks. Thus, we've increased our exposure in such retail companies as Talbot's (TLB) and American Eagle (AEOS). Although Coach Inc. (COH) is more of a luxury goods retailers, we've owned them all year because they will benefit from increased store openings. They have very strong brand loyalty.

Q: Any other industries you're moving towards?

A: We got back into some advertising stocks. Interpublic Group (IPG) just put out better-than-expected earnings numbers. It's a little early, but I think advertising (radio, TV, etc.) will benefit from an improved pricing picture. Renewal rates will pick-up somewhat, and better contracts will be awarded to advertising firms.

Q: Polycom has done extraordinarily well this year. What's the story with them?

A: Polycom is a maker of video-conferencing equipment.

Like most tech companies, they were under pressure in the first half of this year. They also faced inventory problems. But as its price declined we bought a position in it and added to it because we liked their management, their range of products, and the fact that they removed their main competitor, PictureTel, by acquiring them.

After September 11, as increasing numbers of business-people became afraid to fly, Polycom really saw its sales pick up significantly.

Q: What is your cash position?

A: As of October 31: 1.2%. We are committed to remain fully invested, even during a tough market environment like we've been having. From Standard & Poor's FundAdvisor


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