New Fund Leaders in a New Market Era

The bear market of the last two years slammed many stock portfolios, and more than a few stock pickers’ reputations.

But the rough times on Wall Street also brought new stars to light in the mutual fund business. Some conservative stock fund managers who sweat the fundamentals have produced superior performance for their shareholders since the market’s bubble burst in spring 2000.

Many of these managers still are little known, but they are gaining attention--and cash from investors looking for funds that may continue to lead in a market environment that is much different from the wild times of the late-1990s.

Here’s a look at five stock funds that either registered gains or lost far less than their average peer during 2000, 2001 and again in this year’s first quarter, and whose longer-term records also are strong:

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Gary Hibler, Robert Zagunis, Jensen Fund (Large-Cap Growth)

Hibler has been aboard since the Portland, Ore.-based fund’s 1992 inception; Zagunis joined in 1993. The fund--whose management team also includes Val Jensen, David Davies and Robert Millen--gained 20% in 2000 and was flat in 2001, whipping the average large-cap growth fund both years. In the first quarter it rose 3.3% while its average peer fell 2.7%, according to fund-tracker Morningstar Inc.

Analysts at Morningstar say the $285-million-asset fund offers a “tamer take on growth investing.”

Zagunis explains the fund’s mission as a search for “the best businesses in the best sectors, regardless of their size--the companies that have a sustained competitive advantage.”

The fund starts by screening for companies that have recorded returns on equity of at least 15% in each of the last 10 years, winnowing the universe of about 10,000 public companies to about 120.

After assessing the quality of management and the business prospects at each of those survivors, the firm trims its list to about 50 companies, then buys only those that sell for 60% or less of the team’s estimate of fair value.

The result is a concentrated fund with about 25 holdings, most of them currently large companies. “With our style, we tend to end up with companies that are No. 1 or No. 2 in their industry,” Hibler said.

The firm’s approach keeps it away from newer companies and those in heavily cyclical industries such as manufacturing, whose fortunes sway with the economy.

That approach also has kept the fund out of trouble, the managers say. “A long record of solid return on equity usually means these companies have a tradition of survival,” Hibler said. “We don’t pay much attention to the economy. We stick to what we know.”

Technology stocks such as Intel Corp. and Cisco Systems Inc. were good to the fund in the late 1990s, but the Jensen team dumped both stocks in 2000 when they no longer passed the initial return-on-equity screen, and both have since plummeted as business in the tech sector has waned.

In the first quarter, as new money came in from investors, the Jensen Fund added to top holdings such as credit card issuer MBNA Corp. (ticker symbol: KRB), financial firm State Street Corp. (STT), transaction processor Equifax Inc. (EFX), clothing maker Jones Apparel Group Inc. (JNY), and drug giant Pfizer Inc. (PFE).

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Ted Kellner, FMI Common Stock (Mid-Cap Blend)

Kellner has managed the fund (known until recently as FMI Capital Growth) since 1981, working with co-manager Patrick English since 1997. The Milwaukee-based fund gained 19.1% in 2000 and 18.6% in 2001, trouncing the average mid-cap blend fund (blend meaning a mix of “growth” and “value” shares) both years. In the first quarter it rose 5.9%.

The strategy, according to Kellner: “We try to buy good businesses with strong management and fair, if not cheap, prices.”

Often that leads the $56-million fund to companies experiencing temporary difficulties, an investing approach that requires patience.

“Our intent is to hold a stock for two to five years,” Kellner said. According to Morningstar, the fund’s annual portfolio turnover rate of 47% is less than half the fund industry’s average.

Kellner believes the small- and mid-cap stocks the fund tends to favor are still the most attractive segment of the market, but less dramatically so than two years ago.

The fund’s portfolio trades for an average price-to-earnings ratio of about 17 based on FMI’s earnings estimates for 2002. Two years ago the fund traded for about 13 times estimated earnings.

Still, by comparison, the large-cap Standard & Poor’s 500 index trades for about 23 times this year’s earnings estimate.

Kellner and English, who focus on “depth and quality of management” as well as valuations, try to meet with executives from every company in the portfolio.

“I’ve been in this business 32 years, and you can kind of tell who’s giving you the straight stuff and who’s giving you a song and dance,” Kellner said.

The fund seeks to limit risk by focusing on companies with recurring revenue streams and stable products--if not a lot of sizzle.

Along those lines, in the first quarter FMI Common Stock added to top holdings such as waste hauler Republic Services Inc. (RSG); insurance holding company Old Republic International Corp. (ORI); and uniform rental firm G&K; Services Inc. (GKSRA).

Republic Services exemplifies the steady revenue idea, Kellner said. “They pick up your garbage every week. It’s a razor-blade type of business.”

The fund remains light on tech and telecom. “In the macro sense, those industry sectors still have problems to work through and they’re still overvalued,” Kellner said. But, “there are always exceptions.”

One of those, he said, is Broadwing Inc. (BRW), which the fund recently bought at about $6 a share, down from its 52-week high of $27.40 as telecom stocks have slumped en masse. Kellner estimates that the former Cincinnati Bell local phone business is worth about $6 a share, so the fund “essentially got the wireless and broadband businesses for free.”

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Andy Knuth, Ed Nicklin, Westport Small Cap (Small-Cap Blend)

Knuth and Nicklin have run the Westport, Conn.-based fund since its December 1997 inception. It gained 13.6% in 2000, 8.2% in 2001 and 3% in the first quarter--relatively modest numbers compared with the average small-cap blend fund. Still, Westport Small Cap, which clobbered its category average in 1998 and 1999, gets five stars from Morningstar for its longer-term record.

Assets in the fund’s retail-class shares total $272 million, but with nearly $1 billion in total assets between its retail and institutional shares, Westport Small Cap is likely to close to new investors within the next month, the managers said.

When prospecting for stocks, the fund managers consider valuations, but, like the Jensen gang, the Westport duo avoids the “deep cyclical” companies that often have the cheapest valuations.

“With those companies, even if you’re right and the earnings improve, you don’t get any benefit from ‘multiple’ expansion,” Knuth said, explaining that investors are reluctant to pay a high “multiple,” or P/E ratio, for earnings that clearly are at a cyclical peak.

Knuth and Nicklin, whose portfolio has a 15% annual turnover rate, emphasize patience as well.

“A turnaround doesn’t happen overnight, although Wall Street often wants that to happen,” Knuth said. “We’re willing to buy when there is little downside because we have a long time frame. This way, much of the risk has been taken out of the stocks.”

The fund managers don’t bother with mathematical valuation screens, Nicklin said, such as looking for stocks with low P/E ratios.

“Everybody does that, so the results are marginal,” he said. “There is no edge.”

Instead, he and Knuth peruse the newspaper lists of stocks hitting new 52-week lows, and scour the financial pages looking for company blowups that could be transitory.

The managers try to be selective, of course.

“Most blowups are not good businesses--they were a figment of somebody’s imagination,” Knuth said. “It’s our job to ferret out the real businesses.”

The managers also like to see a catalyst for improved earnings on the horizon, Knuth said.

After the Sept. 11 terrorist attacks, for instance, the fund added to its holdings in insurance broker Hilb, Rogal & Hamilton Co. (HRH) as insurance premiums clearly were heading higher.

The fund also bought Saks Inc. (SKS) stock when the shares were being “thrown out” for about $5 in early October, Knuth said, because of worries over the flagship store on New York’s Fifth Avenue.

“We didn’t think New York City and Saks were going out of business,” he said. The stock’s price now: about $13.

Early in the first quarter the fund added to some of its energy holdings after natural gas prices dropped sharply, a situation the fund managers correctly saw as temporary.

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David Herro, Oakmark International (Foreign Stocks)

Herro has managed the fund since 1992; co-manager Michael Welsh came aboard in 1995. The Chicago-based fund gained 12.5% in 2000 and lost 5.1% in 2001, comfortably beating the average foreign stock fund both years. In the first quarter it jumped 11.5%.

As Herro explained the $1-billion fund’s approach: “We try to put together a portfolio of the highest-quality value stocks in the world. We don’t worry too much about what region or industry they’re in, or their weighting in the global indexes.”

That company-by-company approach leads to a portfolio whose performance doesn’t necessarily correlate closely with the major indexes of foreign stock markets’ combined performance.

“We view that as a positive, although some people might not,” Herro said. “We’re paid an active management fee. If you want a global index fund you can get one at Vanguard for one-third the fee.”

Herro and Welsh seek companies selling at an estimated 30% discount to their intrinsic value, and like the other managers featured in this article, they consider cutting back on those holdings as they reach fair value.

That discipline generally has protected investors in down markets: Oakmark International lost 7% in 1998 as its Pacific Rim and Latin American investments got hammered. But patience paid off as those holdings rebounded in 1999 and 2000. Even in 1999’s tech-dominated market, the value-oriented fund gained a respectable 39.5%.

Herro said he and Welsh screen for stocks with low price-to-cash-flow ratios, but also “rely on our intelligence network” of company managers for ideas. Herro, Welsh and their four analysts say they visit about 1,000 companies a year, picking the brains of executives not only about their own business prospects, but also about competitors or other companies on whose boards they may sit.

Herro said he also tries to be opportunistic, noting, for example, that he bought stocks in markets such as Singapore, Australia and Hong Kong in 1997 and ’98 when a series of shocks to the Pacific Rim sparked a widespread sell-off.

The fund’s first-quarter purchases included Henkel (U.S. ticker: HENKY), the German maker of cleaning and cosmetic products; British pharmaceutical giant GlaxoSmithKline (GSK), which Herro said has a promising pipeline of new products and a strong distribution network; Pernod-Ricard (PDRDY), the French liquor maker that has expanded its product line; and Swedish wireless phone equipment maker Ericsson (ERICY), which has taken steps toward a turnaround, Herro said, including shedding its money-losing handset division.

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Thomas Plumb, Thompson Plumb Balanced (Stock-and-Bond Mix)

Plumb has managed this Madison, Wis.-based fund since 1987; David Duchow is the associate portfolio manager. Thompson Plumb Balanced gained 10.2% in 2000 and 11.1% in 2001, easily beating its average peer fund both years, and was up 3.7% in this year’s first quarter.

Like a typical balanced fund, it owns a mix of stocks and bonds, usually keeping about 65% of assets in stocks, although the percentage can range from 55% to 70%. The bond side of the portfolio is expected to reduce the fund’s overall volatility.

Plumb looks for stocks of any size that can benefit from a “catalyst that will change [how investors perceive the company] and eventually lift the share price.” The objective isn’t to find dirt-cheap stocks, he said, but “stocks that will become expensive.”

He does that by looking for companies with problems he believes will be short-lived, he said.

“One of the reasons we’re successful is that we look ahead over the next year or even the next three years, not just the next quarter,” Plumb said. “We’re not always right, but we minimize risk by waiting until the concerns are fully reflected in the stock’s price.”

As an example, the $107-million fund added significantly to its stake in hospital operator HealthSouth Corp. (HRC) when the shares slid from nearly $15 at the start of the year to about $12 recently on concerns that new government reimbursement rates might crimp revenue.

The fund also added to longtime holding Merck & Co. (MRK) when that stock dropped from as high as $93 in 2001 to about $58 recently amid expectations of flat earnings over the next few quarters. Plumb and Duchow expect the drug firm’s profit to accelerate in 2003 as new products come to market.

Plumb called Merck a “tremendous value” at about 18 times this year’s estimated earnings. Investors have punished the stock because of concerns about key patent expirations on the horizon, but Merck “spends $2 billion a year on research and development and we’re confident that that money is not being burned up,” Plumb said.