) draws primarily from both the Russell 1000 Growth and Russell 1000 Value Indexes for its possible investments. Co-manager David Poiesz is in charge of the fund's growth holdings, while lead manager Chris Leavy oversees the value side.
For the year ended Aug. 31, the fund returned 18.6%, vs. a 13.7% gain by the average large-cap growth fund, and a 12.6% rise by the S&P 500 index. Over three years, the fund recorded an annualized return of 12.7%, vs. 10.1% for the peer group and 12% for the index. Over the five-year period, the fund lost 2%, compared with an 8.2% plunge by the peers and a 2.7% drop for the S&P 500.
standard deviation, a measure of volatility, was 10.5, vs. an average of 13.92 for large-cap growth funds. It has a 91% turnover rate, somewhat higher than the 84.8% average for the peer group. Its expense ratio (0.89%) is well below the peer average (1.41%). Based on risk and return characteristics over the last three years, Standard & Poor's gives the fund its highest rank of 5 Stars.
Carol Wood of Standard & Poor's Fund Advisor spoke recently with Poiesz about his investing strategy. Here are edited excerpts of their conversation:
Can you describe your investment methodology? It's a combination of value and growth philosophies. The value strategy is based upon the belief that three-year earnings power is the principal driver of success. We look for companies that are attractively valued, and poised to grow handsomely over three years.
On the growth side, which I oversee, we approach things with a 12- to 18-month time horizon, paying attention to valuation. But more importantly, we ensure that we have above-average revenue and earnings growth in the portfolio at all times. I want mid-teens earnings growth, without paying too much for it.
Does the fact that lead manager Chris Leavy supervises the value portion of the portfolio skew the fund more towards value? It's been very close to 50-50 since earlier this year. It had been skewed more toward value in the previous two years.
How do you and Leavy select stocks? Each of us builds our portfolios independently. On the value side, Chris does a thorough analysis of the three-year earnings prospects of the company, its valuation, and whether the growth prospects warrant buying the stock. He has a smaller portfolio, about 40 stocks, which makes sense because he's not taking a lot of valuation risk and has the luxury of looking out over three years.
On the growth side, I typically keep a 60-80 stock portfolio. I believe in more diversification because I'm taking greater valuation risk. Occasionally I get involved with controversial growth names. I'm willing to get into a stock early when I see something "growthy" and attractively priced that Wall Street doesn't wholeheartedly agree with.
Can you cite an example? A year ago, for instance, Microsoft (MSFT
) was in a no-man's land -- many didn't think it qualified as a growth stock any longer. My view was that Microsoft was not only cheap but in the process of re-accelerating. They've reported three good quarters that have exceeded the Street's expectations. Microsoft now is in both sides of our portfolio and represents our largest holding, at 4.8% of assets.
What are your buy criteria? On the growth side, we require an attractive valuation and a good unit-growth dynamic. I also like companies with strong balance sheets and low debt levels. My average company on the growth side has about an 18% debt-to-total-capital ratio -- I don't like to take financial risk.
What are your top holdings? The top 10 holdings as of Aug. 31 were Microsoft, 4.8%; Liberty Global (LBTYA
), 2.8%; BP (BP
), 2.6%; Altria Group (MO
), 2.6%; Honeywell International (HON
), 2.5%; Wells Fargo (WFC
), 2.4%; Citigroup (C
), 2.4%; JP Morgan Chase (JPM
), 2.0%; Cendant (CD
), 2%; and Halliburton (HAL
However, because the value side is more concentrated, the top holdings include more value names than growth.
What would be a top growth holding? One of our top 20 holdings as of Aug. 31, EMC (EMC
), is strictly a growth holding. Halliburton and Microsoft are owned by both sides.
According to the fund's literature, you look for companies that increase revenue through rapid sales growth rather than cost-cutting. Why? If you're just cutting costs or improving margins by reducing headcount, you may get earnings growth for a little while, but you can't sustain that forever. On the other hand, if you're introducing new products, and provide services that are stable and growing, that's more sustainable.
What are your sell criteria? I look for unit and revenue growth in the high single- to double-digits. If I'm expecting 15% earnings, but the company is going to give only 5%, I will likely sell the entire position. If it's temporarily at, say, 8% to 9%, I'm willing to accept a few quarters of setbacks, as long as the 18-month time horizon looks reasonable. But I don't buy companies that don't earn money.
Why else would you sell a stock? When the valuation reaches its target, as well as when something occurs to change the story. In the fairly distant past, the fund had a big position in Russian oil giant Yukos. When things initially changed for the worse, we bit the bullet and sold it. By unloading early enough we didn't get wiped out.
What are your largest sectors? As of Aug. 31, our top five sectors comprised information technology (25.1% of the fund), financials (18.2%), consumer discretionary (13.4%), industrials (10.8%), and energy (9.9%).
This portfolio does overweight and underweight certain individual sectors, but not in a dramatic fashion. Currently, we have three substantial underweights -- consumer staples, financials, and health care -- and three substantial overweights -- consumer discretionary, industrials, and information technology. The other sector allocations are within a percentage point of the respective weights in the benchmark, the S&P 500 Index.
Do you invest in foreign stocks? Both Chris and I have a small number of foreign holdings, but we try to keep this allocation under 10%.
Do you have an outlook for the market and for your asset class? Hurricane Katrina will surely be a negative in the short run. I think the Federal Reserve has been raising interest rates in order to be at a neutral stance, but my feeling is that the U.S. and global economies are still quite healthy. One could argue that rebuilding will stimulate the economy -- I think that will be the case in the longer term.
With respect to the various styles, large-cap growth has been doing better than small-cap growth, which is a bit of an anomaly. And growth overall has been doing worse than value. We've had five years of value stocks outperforming growth. Growth today is as relatively besmirched as value was five years ago. Growth has been out of style.
When might we see a change in performance of growth stocks? I think growth stocks are starting to show some life, which is typical of this part of the economic cycle. Growth stocks don't do well during a recession. So early on in the economic recovery, they tend to lag. But as it gets harder for companies to show earnings growth, they come back to the fore. And that's where we are now.