Oak Associates' Founder Relying on Power of Concentration

By JOSH FRIEDMAN

Sept. 19, 2000 12 AM PT

TIMES STAFF WRITER

It’s no wonder the investing Web site Maxfunds.com has dubbed Oak Associates founder James D. Oelschlager “Goldschlager.”

In this year’s struggling stock market, Oelschlager’s three mutual funds--White Oak Growth, Pin Oak Aggressive Stock and Red Oak Technology Select--have been gleaming. Through last week, the funds had produced year-to-date total returns of 31.6%, 47.5% and 63.2%, respectively.

Those results were trouncing the blue-chip Standard & Poor’s 500 index, which was up less than 1%.

Beating the S&P; has been a seemingly easy task for Oelschlager since 1998. His strategy: Focus on a relative few stocks, and emphasize technology.

But amid Oak funds’ continuing winning streak, independent fund researchers such as Maxfunds and Morningstar Inc.--while lauding Oelschlager’s performance--have raised some warning flags.

For one, they note that the Oak funds’ overlapping and highly concentrated portfolios, while paying off spectacularly so far, also raise the funds’ risk levels.

Also, many of the stocks Oak favors sell for extremely high price-to-earnings ratios, which means there’s little room for error by the companies.

What’s more, Oelschlager’s performance could suffer if too much “hot money” pours into the funds--only to exit quickly if they turn south.

Oelschlager, a former corporate pension fund manager who founded Oak in 1985 in Akron, Ohio, met with The Times on a business trip to Los Angeles last week, and discussed Oak’s strategy and whether the firm can keep its streak going.

Question: Clearly, you believe that the way to beat the market is to manage concentrated portfolios. How do you focus them?

Answer: We concentrate two ways: by investing only in the industries we think are attractive, and by having a relatively small number of names in our portfolios. The funds each have about 24 names and, were it not for the rules of the Securities and Exchange Commission, we would probably have fewer. In fact, for our individual accounts, which is the bulk of our business, we intend to have fewer names than are in the funds.

You can overdo diversification and it waters things down. We think a lot of managers out there--probably 80% of them--are really closet indexers. But, obviously, nobody has ever called us an indexer.

Q: With White Oak strictly in technology, health-care and financial stocks, and Red Oak and Pin Oak all or virtually all tech, you’re plainly not worried about matching the S&P;’s sector weightings.

A: I think a lot of our peers recognize that they can’t beat the market so they tend to act like indexers because if they don’t under-perform by too much, they don’t get fired and they can justify their fee. It’s what I call defensive ball. We don’t play defensive ball.

We think we’re still in the early stages of this tech revolution. People will be surprised at how high productivity stays, how good corporate profits are and how improved the standard of living is going to be. We’re now able to double our economic pie in 15 years, which is terrific. It used to take us multiple centuries [before the Industrial Revolution] to double our economic pie.

Q: Within tech, where are you shopping?

A: Two areas we have focused on in the recent past are data storage and fiber optics. EMC [ticker symbol: EMC], Brocade Communications Systems [BRCD] and companies like that in data storage; JDS Uniphase [JDSU] and Ciena [CIEN], for example, in fiber optics. There’s been a staggering increase in traffic going over the Net and every time you send some stuff, you’ve got to store some stuff. The Internet is still pretty much U.S.-centric, but there’s a whole world out there that has to be networked together.

Q: What have you been buying most recently?

A: One of the newer names we’ve been adding is Juniper Networks [JNPR], which produces high-end routers, the really big things for serious Internet volume.

Q: You own a lot of the same stocks in all three funds. Is there a danger in that sort of overlap?

A: Fortunately, we’ve been in the right areas so far. And those haven’t been the areas we’ve been in for my 30-year career. At one time, energy and utilities were our biggest areas. But, given the overview we see, I don’t expect to be going back there any time soon. You do have risk if you run concentrated portfolios, but you also have the rewards if you’re right.

Q: Now that you’ve mushroomed to nearly $10 billion in assets for the three funds combined, with a total of $30 million pouring in on a typical day, are you concerned about being able to put all the new cash to good use?

A: Well, $10 billion is a nice number but that’s not a Janus-type number or a Fidelity-type number, so we think we still have room to work with. Our names are basically large-cap, and if it’s a mid-cap stock, it generally has good trading volume.

We have a lot of names like American International Group [AIG] and Citigroup [C], Merck [MRK] and Pfizer [PFE], Cisco [CSCO] and Intel [INTC]. Those are pretty big market-cap stocks, not a problem to trade.

So we have no plans to close any funds. But if, down the road, we see that things have changed and assets have grown too much, that’s something we would consider.

Q: One Web site suggested that White Oak, known for its low turnover, could face a ticking tax time bomb because of capital gains that might have to distributed to shareholders at some point.

A: We do have low turnover and that’s our style with taxable accounts and nontaxable accounts. But let’s say one went into the funds for three years and then exited. The likelihood is that there’s going to be more unrealized gains in three years than there are today, unless I change my style radically. Also, because White Oak and the other funds have enjoyed large cash flows, you’ve seen the asset size appreciate from [investors’] contributions, so the unrealized gains are not as dramatic as you might think.

Q: More active fund managers are beating the S&P; 500 this year than we’ve seen in a while. Is this finally the so-called stock-picker’s market that people have been talking about for years?

A: Well, getting into the right areas comes first and it’s even more important than picking the right stocks. We’ve avoided the “dot-com” crowd. There’s been a lot of disappointment over there.

We’ve been playing basically the infrastructure side. We know the infrastructure is going to survive. We’re not sure who’s going to be sending stuff over the Internet but we know who’s going to be building the Internet.

Q: In White Oak, you’ve also bet on health care, particularly the drug group. Are you concerned about the latest talk of government price controls?

A: Periodically we see political wrangling over drugs and prices. I don’t know how it will wash out. Nobody does. But you can rest assured that more people are getting older and, the more people get older, the more they are going to take pills on a regular basis. Which reminds me--I’ve got to take mine. And, of course, the pipeline of new drugs has been accelerating.

Q: So the sector weakness we’ve seen lately could be a buying opportunity?

A: Right. We tend to look longer-term, which explains our low turnover. We’re not just looking to the presidential election, we’re looking over the next three or four or five years.

Take Eli Lilly [LLY], which had a high-profile event a couple months ago when it learned that the patent for Prozac was going to expire a couple years earlier than expected. It was not a surprise that it was eventually going to come off patent. But the market instantly dropped the value of Lilly by 30%. It’s hard to imagine that the company’s inherent value could have dropped that much.

For everybody who sold a share of the stock that day, somebody bought a share. My guess is that in three years, people who bought that day at the bottom of the correction, if you will, are going to look smarter than the people who sold the stock.

Q: You also remain bullish on the financial sector. Is that for demographic reasons as well?

A: Not so much demographic as the fact that the world has created a staggering amount of wealth in the last 10 years. I’m going to be so bold as to suggest it’s going to create at least that much in the next 10 years, and people have got to handle this money. Citigroup, with its operations internationally, is likely to see some of that money flow through. And we’ve also got Morgan Stanley Dean Witter [MWD], which handles a lot of this money for individuals.

Q: Going forward, it sounds like you’re sticking with your formula.

A: Right. We think a lot of people confuse motion with progress--but jumping around and doing a lot of trading is not necessarily the way to go. Active management doesn’t necessarily mean active trading. We do what we think is active management of our portfolios: We watch them but we don’t do a lot of trading.

Josh Friedman can be reached at josh.friedman@latimes.com.

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Tall Trees Among Stock Funds

Oak Associates’ White Oak Growth, Pin Oak Aggressive and Red Oak Technology Select stock mutual funds have dramatically outperformed the Standard & Poor’s 500 index in recent years. A look at the funds’ results:

* Through Friday

Note: Red Oak fund was launched in 1999.

About the Individual Funds

White Oak Growth: Invests primarily in mid-size and large stocks. Assets: $6.2 billion.

* Major holdings at midyear: Eli Lilly (LLY), AppliedMaterials (AMAT), Ciena (CIEN)

* Total number of stocks held at midyear: 23

Pin Oak Aggressive: Invests primarily in small and mid-size stocks. Assets: $1.2 billion.

* Major holdings at midyear: Cacheflow (CFLO),

Foundry Networks (FDRY), Cisco Systems (CSCO)

* Total number of stocks held at midyear: 25

Red Oak Technology Select: Invests primarily in tech stocks. Assets: $1.5 billion.

* Major holdings at midyear: Newport (NEWP),