|
|
|
|
Fund Spy
3 fund firms with new momentum
It's about time for this bold approach to make a comeback. These small firms do it well.
By Morningstar
Momentum investing is a bolder flavor of growth investing. In the 1990s, it became downright mainstream as growth companies kept growing faster and their stocks kept ascending thanks to ever more heroic assumptions.
Today, those strategies have been pushed back out to the fringe. The bear market was a perfect storm for them because it punished high valuations (measures like price/earnings and price/sales) more brutally than anything else. But I figure they've spent long enough in the dog house that it might be time for them to be rehabilitated and produce respectable returns.
Whether you opt for a more traditional growth fund, such as the insanely popular American Funds Growth Fund of America (AGTHX), or choose a momentum fund, it's worth understanding how momentum works.
Going with the mo'
The central underpinning of momentum investing is that companies that beat earnings estimates will do so again, and those that fall short will fall short again. Studies have found this tends to be the case, though certainly with exceptions. By the same token, stock prices that have gone up faster than the market tend to keep going up.
Momentum funds are usually driven both by fundamental growth factors, such as earnings and sales growth, as well as by price charts. Most funds like to emphasize the fundamental side, but, where there's a momentum fund, there's a chartist. Typically, the managers of momentum funds let their computers do a lot of the work for them, and therefore these offerings are rather thinly staffed. Moreover, their focus on fairly short-term events mean they don't dig as deep or build models as complex as those you'd see at more fundamental shops like American Funds, Wellington or Primecap.
Related news and commentary on MSN Money
The real flaws
There are two key drawbacks to momentum investing.
- As I noted, the strategy can get hammered on occasion because companies that are beating estimates usually have steep valuations. That means one small misstep can get the stock crushed as all those momentum funds rush for the door.
- Second, because much of the work is quantifiable, it's hard to maintain your edge. Computing power is cheap, and lots of clever folks are constantly crunching data to see how best to play momentum. This challenge has been made even tougher by the rapid proliferation of hedge funds. Momentum is in many ways a trading strategy, and that means there are some hedge funds that are very good at it. Because of that, the window for exploiting short-term market inefficiencies with momentum strategies is probably smaller than it has ever been.
A little while back, I was part of a group of fund analysts from Morningstar who took a trip to visit asset managers in Philadelphia, including three momentum shops. I visited Turner Investment Partners and Friess Associates, while my colleagues met with Gardner Lewis. Each is among the better members of the momentum club. They have some similarities, yet there are key distinctions that have led to big differences in performance.
Pilgrim Baxter, home to the former highflying PBHG funds, would have once been a mandatory stop on this visit, but the firm has imploded. While the scandal that engulfed founders Gary Pilgrim and Harold Baxter didn't have much to do with momentum, the funds' poor performance is a warning of the downside to the strategy. They once produced great returns, but assets grew to the point where it hobbled their ability to trade effectively. In addition, competitors gained on the firm's quantitative work, and the PBHG funds never really recovered. See PBHG Growth's (PBHGX) record for proof.
Turner Investment Partners
Located in suburban Philadelphia, Turner Investment Partners goes to great efforts to avoid following in PBHG's footsteps. The folks at this shop study their capacity closely and will close a fund when it approaches that capacity limit in order to preserve performance. Keeping a fund to a manageable size is especially important to momentum funds because they need to maintain the ability to trade in and out of stocks quickly when earnings information is released. Moreover, they're constantly working on their models to keep them up to speed. The firm also has a more robust compliance effort to keep it free of any of the ethical problems that beset PBHG.
The basic idea at Turner is to find companies with accelerating earnings. The managers keep sector weightings in line with the appropriate growth indexes in order to make their funds a pure play on the strategy without any top-down effects. They back up their quantitative work with fundamental research by a modestly sized analyst staff. This may help them sidestep some problems and sniff out some of the better opportunities, but the funds are always run to the far right (high P/E, high growth rate) of the Morningstar style box regardless of circumstances.
Thus, Turner had the pedal to the metal in 1999 when growth was paying huge gains, and the shop kept it there when growth went off a cliff in subsequent years. Turner Midcap Growth (TMGFX) posted the following consecutive annual returns starting in 1999: 125%, -8%, -28%, -33%, 50%, and 11%. Clearly, Turner is the hare to Ariel's (ARGFX) tortoise.
So, what you get are funds that are very predictable for purposes of portfolio-building. The fund consistently outperforms in growth years and underperforms in value years. You could pair it with a deep-value fund and get a decent portfolio. On the other hand, it is mighty wild from an absolute performance standpoint, so you have to stomach the -33% years to enjoy the good ones.
Friess Associates
Located in Wilmington, Del., and Jackson, Wyo., Friess Associates does everything a little differently at their Brandywine offerings. And that's a good thing. Compared with Turner, this firm cares more about valuations (no Google (GOOG, news, msgs) in the Brandywine Fund (BRWIX)) and not at all about their benchmark's sector weightings. Put those traits together and you get a much more wide-ranging fund. Brandywine has no problem dumping tech in favor of energy if that's where they see earnings growth at decent valuations. Thus, they pared tech and added energy well ahead of Turner. As a result, they lost less in the bear market and have gained more this year. Here are Brandywine's calendar-year returns, starting with 1999 (note the fund 1999 gain was less than half of Turner Midcap's): 54%, 7%, -21%, -22%, 31%, 13%.
The most striking element about Friess, though, is its emphasis on legwork. This firm has far more analysts than most momentum shops because folks here aim to stay ahead of the curve by talking with the company, customers and suppliers. They do these channel checks to find out how a company is doing before they announce their quarterly results. The cool thing about this approach is that legwork won't likely become obsolete. It's much easier for competitors to write a clever new program than it is to hire 30 experienced analysts to make channel checks.
Lest you think I'm talking about another Dodge & Cox, have a look at the funds' turnover. Brandywine trades in excess of 200% of the portfolio over the course of a year. In short, they're very focused on the short term. If a stock is behaving badly, they'll shove it out in favor of one that is more clearly on the upswing.
Gardner Lewis
Think of Chesapeake Core Growth (CHCGX) as Brandywine on decaf. This relatively unknown fund is run by Whit Gardner and John Lewis, who used to work at Friess Associates. Like Friess, they focus on channel checks to stay ahead of the crowd. Unlike Friess, they have a longer time horizon and run turnover that has been in the 60%-to-100% range in recent years.
Gardner and Lewis also limit exposure to cyclical stocks. Their sector-weighting limits are loose, but, right now, Chesapeake Core has a much smaller energy stake than either Turner Midcap or Brandywine -- and therefore tends to be more of a pure-growth fund. This particular offering is a large-growth fund, whereas Brandywine mixes large and small, and Turner Midcap sticks to mid-caps. (Friess' large-cap fund is Brandywine Blue (BLUEX), while Turner's is Vanguard Growth Equity (VGEQX). Turner is the advisor on the Vanguard fund.)
On the downside, Chesapeake Core's expense ratio is a little steep at 1.33%, and Gardner Lewis doesn't have as big a staff as Friess.
It shouldn't come as a surprise that this fund's annual returns since 1999 fall somewhere between those of Brandywine and Turner Midcap: 48%, 6%, -13%, -24%, 42%, 11%.
by Russel Kinnel, Morningstar
|
|
|
|
