Can This Value Fund Shed Its Volatility?


By Amey Stone Value funds, which seek out stocks that are cheap relative to the market, are traditionally a lot less volatile than their growth-oriented peers. Based on its name, investors might assume that Gabelli Blue Chip Value would be among the more stalwart of the value group. Yet for the past year, that has been far from true.

In the first three quarters of 2002, the fund (GABBX) fell a punishing 50%, as manager Barbara Marcin positioned the portfolio for an economic rebound and a return of investor confidence that failed to materialize. "I was looking for a stronger recovery earlier than I should have been," admits Marcin, who thinks the looming war with Iraq has kept chief executives sitting on their wallets far longer than the economy's underlying strength would otherwise dictate. Among her way-too-early picks was battered telecom-equipment maker Lucent Technologies (LU).

However, Marcin doesn't sound too apologetic -- and with good reason. In the fourth quarter of 2002, it took only a glimmer of improved investor sentiment and a perking up of wilted corporate earnings for the fund to shine. It gained 20%, vs. just 8% for the Standard & Poor's 500-stock index. Even lowly Lucent is up 180%, to $1.70 on Feb. 10, from its October, 2002, low. Hewlett-Packard (HPQ), another large holding, is up to $16.64, from a low last year of $10.75.

OLD MEDIA VALUE. This year will be the acid test for Marcin's bold strategy of picking out-of-favor stocks, primarily due to weak business conditions. Her intention is to load the fund with names that will turn around in one to three years. Such stocks should get a double lift -- when earnings and cash flow improve, and also when they regain investors' confidence and thus earn a higher price-earnings multiple.

AOL Time Warner (AOL), a top fund holding, is a good example of a stock that has a long way to go on both counts. Its earnings plunged as the online media business struggled, and the merged giant has been a chronic disappointment to investors -- their anger and anxiety further roiled by the departure of the merger's principal architects. Yet Marcin says her analysis shows that the old Time Warner businesses alone are worth $15 or $16 a share. Add $3 or $4 for America Online, she figures, and you get close to $20. AOL Time Warner shares closed Feb. 10 at $10.36.

To make it into Marcin's portfolio, a stock must have at least 30% upside in a recovery. "We spend 10% of the time figuring out if the stock looks cheap -- and 90% of our time figuring out what's going to happen in the next year that will improve its earnings and cash flow," explains Marcin.

STAYING POSITIVE. Another large holding that the fund purchased in the last six months is Honeywell (HON). The aerospace and industrial-equipment maker that General Electric (GE) tried to buy for more than $50 a share in 2001 is now at $23.63 and has a price-earnings ratio of just 14. Its stock has been hammered by the weak capital-spending environment. And Honeywell has also been knocked down for asbestos exposure and pension liabilities. Marcin believes the lower dollar will help its sales, and she expects underlying earnings power to kick in when the economy improves.

Thus far in 2003, Gabelli Blue Chip Value has stayed in positive territory, with a gain of 1.4% through Feb. 9. That showing earned it a spot in the top 10% of all funds in the large-cap value category this year. But it's early yet, cautions Morningstar fund analyst Shannon Zimmerman.

"It's great that the fund is perking up," Zimmerman says. "But over time, the three-year trailing returns land it very near the bottom of the category." Although Zimmerman says he's rooting for Marcin, the fund, with its rocky results and steep 1.75% expense ratio, doesn't meet his own personal acid test. That is, he wouldn't recommend it to his mother.

HEAVY SWINGS. The big danger with Marcin's strategy, as 2002 results clearly illustrate, is getting in too early. But now that some of her most beleaguered stocks have started to move up, she feels they have a long way to run. HP, up about 60% from its lows, is just starting to restore its reputation and remains cheap. It has a p-e of 14 -- far lower than other tech giants, such as IBM (IBM), at 18, or Dell Computer (DELL) at 30. Says Marcin of HP: "It's putting one foot in front of the other and achieving the earnings goals it has set out for itself."

She's equally bullish on Lucent. Marcin thinks the new management team's goal of turning cash-flow-positive this year is within reach. "The company certainly has lost credibility with investors, so that's why I think there is upside if credibility comes back," she says. With profit margins improving and massive cost-cutting under way, "a little pickup in sales can make a big difference," she says.

Gabelli Blue Chip Value has been much more volatile than its peers. But, as Marcin notes, the typical value fund buys a lot of stocks that are underfollowed and in industries that seem unlikely to ever garner much investor enthusiasm. "A lot of time they're companies that have always been cheap, and therefore they will always be cheap," she says.

Her approach packs a lot more punch -- on both the upside and the downside. That may be more excitement than the typical fund owner is looking for. But for investors brave enough to be scouting out funds that should prosper once the economic recovery gains steam, Gabelli Blue Chip Value has lately proved its mettle. Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column


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