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To print article, click Print on your browser's File menu. Go back Posted 8/29/2005 |
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Fund Spy A fund that makes conviction count Matrix Advisors Value is one good example of how a focused, concentrated, low-turnover mutual fund can produce strong results over the long term. By Morningstar We use the phrase "investing with conviction" as a way of distinguishing those managers who we believe have the potential to best their rivals and benchmarks by a wide margin by building a compact portfolio of well-researched stocks that they hold for the long haul. In a research article published in the July 2004 issue of Morningstar FundInvestor, we showed that managers who invest with conviction tend to dramatically outperform their peers. We found that such conviction typically manifested itself in two ways: low turnover rates and relatively concentrated portfolios. While studies of each trait by itself have yielded mixed results, in conjunction these two factors point toward funds with the ability to outperform going forward. An analysis of the subsequent five-year rolling returns of funds with concentrated, low turnover portfolios showed that most quite handily beat their respective category average over that five-year period.
Thus, as part of a new, regular column called Focused 10 appearing in FundInvestor, we will track 10 funds from the FundInvestor 500 -- our list of the industry's best and most notable funds. The funds that we choose will meet specific criteria (offerings in the lowest quartile of their respective categories in turnover and number of holdings) and that have proven management teams with experience running focused portfolios. Each month in the Fund Spy, we will take an in-depth look at one of the funds on the Focused 10 list. By doing so, we hope to flesh out some of the methods and strategies these exceptional managers use to pick stocks. Related news and commentary on MSN Money David Katz finds bargains among giants In a recent issue of FundInvestor, we highlighted Matrix Advisors Value (MAVFX), a fund with a bit of a contrarian streak. As smaller stocks have ruled the roost for the better part of six years, this fund has been steaming full force in the opposite direction. While cognizant that mega-cap stocks have been distinctly out of favor the past 18 months, lead manager David Katz says that it's the fund's disciplined, bottom-up process for picking stocks that has led him to invest in nine of the 15 largest companies in the U.S. The process itself is simple enough. Katz and his team use eight quantitative valuation models to screen a universe of 1,500 large-cap stocks. The models are equally split between absolute measures such as earnings/dividend growth and return on equity, as well as relative valuation metrics like price/sales, price/book, and price/earnings. The goal is to identify companies selling at a steep discount to the team's estimate of their intrinsic value. Typically, prospective holdings need only qualify on any two of the eight different models. The team then follows up with a fundamental analysis of a firm's financial statements and looks for industry leaders with sustainable competitive advantages and/or catalysts to spur a rebound in what can sometimes be beaten-down stocks. That deep-value approach may not sound particularly daring, but Katz flavors it with an opportunistic flair that includes the flexibility to seek out stocks in traditionally growth areas of the market. "Traditional large-value stocks are now 18% above historic price/earnings, while traditional large-growth stocks are 7% below historic values," Katz says. Unlike other value-oriented managers, Katz also isn't afraid to dive into tech stocks when his models suggest that they are attractive. Such is currently the case, as nearly 20% of fund assets are devoted to hardware names -- more than double the stake of its typical large-blend rival. Weak lately, strong long-term Management's conviction in its process certainly hasn't won any fans of late. The fund has been mired in the bottom decile of the large-blend category since the beginning of 2004. That's a common fate among concentrated, low-turnover managers, as they tend not to sell out-of-favor picks. The more important question is whether they're right over the long term. This fund has proved itself in that regard: For the trailing five years through July 19, 2005, the fund's 6% annualized return has bested 95% of its peers and topped the S&P 500 index ($INX) by a whopping 8 percentage points per year. The fund also has shown itself to be a fine steward of shareholder interests. The board of directors delayed and then ultimately rejected a move to become part of the Strong family of funds after news came out about that now defunct fund shop's role in the industry's trading scandal. Also, Katz has invested a substantial amount of his own personal assets (more than a third of his liquid net worth) alongside those of shareholders. The fund's historical turnover is higher than most of the funds on our Focused 10 list, but part of that trading is used to harvest tax losses -- in stocks that are subsequently repurchased -- to help offset capital gains and reduce distributions to shareholders, making the fund extremely tax-efficient. In the end, Matrix Advisors Value exemplifies many of the traits we look for in a focused, low turnover fund. Its manager invests with conviction using a flexible style that is able to root out bargains that pay off over the long haul. While short-term volatility can be high, it reiterates the need for investors to have the same patience and conviction as that of the manager in order to reap the gains of this approach. |
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