Brent Lynn has beaten 96 percent of rivals since taking over the Janus Overseas Fund (JNOSX) in 2003, in part by investing in stocks from emerging markets such as India and Brazil. Now Lynn is finding attractive bets closer to home. Delta Air Lines (DAL), Ford Motor (F), and Bank of America (BAC) were among the top 10 holdings as of Sept. 30 at the $13 billion mutual fund. Over the past three years, Lynn has more than doubled his weighting in U.S. stocks, to 20 percent—the most the fund is allowed to hold—while cutting emerging-market holdings to 23 percent from 37 percent. "Some of the best investing opportunities may be in the developed markets of the U.S. and Europe," says Lynn from his office in Denver, where Janus Capital Group (JNS) is based. "Growth may not be as exciting as it is in some emerging countries, but there are interesting things going on under the surface."
Lynn, 46, is one of a growing number of money managers who say the rush into emerging-market stocks has driven up their prices to the point where it's hard to find bargains. "The emerging-market story is as great as it has ever been, but the prices you are being asked to pay to participate are increasingly full," says Simon Hallett, chief investment officer at Harding Loevner in Somerville, N.J., which has $10 billion in assets under management, including $4 billion in equities of companies in developing countries.
The MSCI Emerging Markets Index gained 19 percent this year through Nov. 5, including dividends, compared with a 12 percent increase for the Standard & Poor's 500-stock index. Emerging-market stocks jumped 79 percent in 2009, triple the 26 percent return of the U.S. benchmark. Since Lynn became manager, Janus Overseas has returned about 19 percent a year, according to research firm Morningstar (MORN). This year it has gained 20 percent.
In the fourth quarter of 2008 and the first quarter of 2009, Lynn pared the number of stocks in the portfolio and put money into companies with the financial strength to survive the crisis. Among them were Hong Kong-based exporter Li & Fung, the biggest supplier to Wal-Mart Stores (WMT), and Mumbai-based Reliance Industries, owner of the world's largest fuel-refining complex. The stocks, now Lynn's two biggest holdings, have been among the fund's top positions for the past four years, regulatory filings show. Li & Fung shares have more than tripled since their October 2008 low; Reliance has more than doubled.
While seeking stocks with strong growth potential, Lynn also looks for what he calls special situations—companies or industries undergoing structural changes that have yet to be recognized by other investors. To Lynn, airlines fit that definition. U.S. carriers have removed seating capacity in the past few years "at a rate we believe is unprecedented since World War II," he says. With fewer tickets available, they can charge higher prices and generate greater profits. The Bloomberg U.S. Airlines Index has climbed 36 percent this year. Lynn owned stakes in Atlanta-based Delta and Houston-based Continental Airlines as of June 30, Bloomberg data show. Continental merged with United Airlines on Oct. 1, creating United Continental Holdings (UAL).
Shares of Ford, Lynn's fourth-largest holding, gained 62 percent in 2010 as it grabbed market share from weaker rivals and commanded higher prices. Ford has the potential to capture a larger piece of the small-car market, Lynn says. Bank of America, whose stock has fallen 18 percent this year, still faces economic and regulatory uncertainty, he says. Lynn is hanging on: "I believe those problems mask the company's long-term earnings power."
The bottom line: Lynn's shifting money in the Janus Overseas Fund to the U.S. is another sign emerging markets may be overheating.