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Mutual Funds
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| | Mutual Funds
Momentum pulls stalled fund out of value trap
Instead of waiting years for out-of-favor stocks to shine, Carl Marker's IMS Capital Value Fund looks for signs that the payoff is coming sooner.
By Timothy Middleton
Some mutual fund managers stick doggedly to their investment style no matter what. Usually, thats good: The value-flavored Yacktman Fund (YACKX) actually lost money during the Internet bubble but sailed through the bear market with double-digit gains each year, and then did even better in last years recovery, up 33%.
Sometimes, however, its a disaster. Henry Van der Eb of Gabelli Mathers Fund (MATRX) was burned by the bear market of the 1970s. He has been so doggedly conservative ever since that hes delivered annualized returns over the last 15 years of 1.9%, less than a money-market fund.
Carl Marker of IMS Capital Value Fund (IMSCX), on the other hand, took the position that if its broke, fix it. He did, and his shareholders can be grateful. This undiscovered fund -- its assets are only $64 million -- deserved its obscurity in the 1990s, but Marker figured out what wasnt working and changed tactics. Over the last three years, annualized returns of 13.5% have propelled the fund into the top 7% of mid-cap funds of its type.
The strategy here has evolved over time, says Todd Trubey, an analyst for fund tracker Morningstar. Like many value managers, Marker was prone to buying out-of-favor stocks years before they regained their luster; holding such dead money is referred to among investors as the value trap.
So Marker took a tip from go-go growth managers and added the concept of momentum to his investment criteria. We demand that we see some kind of positive momentum developing within a companys business, sales, earnings or stock price, he says. Meanwhile, he lets downtrodden stocks season at least two years in the basement before buying. We want to make really sure were not too early.
Putting Marker to the test
Markers judgment will be tested in coming months at Tyson Foods (TSN, news, msgs), which is the funds biggest holding, at 6% of its assets. Last week, Tyson lost a class-action lawsuit in Alabama over its meat-packing business and faces a penalty of $1.28 billion.
The contrarian investor didnt anticipate that, or the December mad-cow scare, when Marker began building his Tyson stake in the latter half of last year. But he likes the companys fundamentals so much that his response to the controversy has been to increase his position.
Tyson is an archetype of the kind of stock Marker likes. It is one of the worlds largest producers of beef, pork and chicken, an industry he describes as immune to product obsolescence, with a long product cycle, a short consumption cycle and very high barriers to entry.
The companys shares, which trade around $16, were going for nearly $25 in 1999, when a series of mishaps and bad management decisions began to unfold amid a diet-conscious nation that was spurning eggs and red meat. By early last year, they had fallen to $8.
At that point we saw several things change, Marker says. Some analysts following the company began revising their earnings estimates upward. Diets such as Atkins and South Beach have made eggs and beef popular again. And after five years, even the worst management team has had a chance to make changes to get things right, he says.
We think this stock has the ability to get back to $25 pretty easily, he adds.
The market reacted mildly to the jury verdict in Alabama. The states juries are famous for granting fantastic tort awards that are slashed or reversed on appeal. According to The Wall Street Journal, the judge overseeing the case described the plaintiffs suit as a very thin case.
| IMS Capital Value top holdings | | Stock | Weighting (%) | Sector | | Tyson Foods (TSN, news, msgs) | 6 | Consumer staples | | XM Satellite Radio (XMSR, news, msgs) | 3.9 | Technology | | Humana (HUM, news, msgs) | 3.1 | Health care | | Service Corp. Intl. (SRV, news, msgs) | 2.9 | Consumer cyclicals | | Rite Aid (RAD, news, msgs) | 2.7 | Consumer staples |
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Note: As of Dec. 31, 2003
Source: IMS Capital Value
Smart, or just lucky?
Midsize stocks have walloped their large-cap rivals over the last five years, delivering annualized returns of nearly 10%, compared with less than 1% for large caps. So a midcap specialist like Marker has market momentum in his favor; rather than savvy investing, he could just be lucky.
Among other factors investors should consider before leaping into the IMS fund are these: It has a highly concentrated portfolio of only 40 to 60 names, so it is much more volatile than a broadly diversified fund -- about 30% more than Vanguard 500 Index (VFINX). And because of its small size, the expense ratio of 1.59% is painfully high, about half again as much as I would prefer to pay.
But whether hes streaking or striding, Marker is moving ahead smartly. Adventuresome investors should give him a look.
A closed-end caveat
When I recommended closed-end municipal bond funds recently, I should've added an asterisk. Actually buying and selling these things is more difficult than we mutual fund investors are used to.
I learned this the other day when I implemented this strategy in my personal portfolio. Two of the funds that were high on my list fell off it when I saw their bid/ask spread was around 12 cents. The reason: Trading in them was minuscule.
I ended up going with another of my original picks, plus a fall-back fund. Fortunately, I had done research on all nine closed-ends that invest strictly in the bonds of New Jersey, where I live and where, therefore, the tax advantages are greatest. The spreads of the funds I bought were tiny, a penny on one and two cents on the other.
Spreads can make a huge difference in this odd little marketplace, where small fish like me can be placing some of the biggest trades of the day. All things being equal, a spread of 12 cents on a fund that trades around $15, as the New Jersey funds mostly do, works out to an immediate loss on the position of 0.8%, since you buy at the ask price but sell at the bid. This assumes the spread will still be wide when you sell, but thats the only reasonable assumption you can make.
When total annual returns are in single digits, as I expect them to be for closed-end munis this year, thats a significant number, reducing my projected profits by around 10%.
So as you study purchasing closed-end funds, add one more statistic to your due diligence: trading volume. The two funds I didnt buy have average daily trading volume of only 5,000 or so shares. The two I did buy trade 16,000 to 27,000 shares daily. More trading almost always means tighter bid-ask spreads.
At the time of publication, Timothy Middleton didn't own any of the securities mentioned in this column. He also controls investments in an S&P 500 index fund.
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