Personal Business: INVESTING
FUNDS WITH A FOCUS
David Quin had been investing in the Yackt- man Fund for only a matter of weeks when he learned last spring that it was spinning off a fund designed to hold just a few stocks. The aim: to concentrate investors' money on star manager Donald Yacktman's 15 or so best picks. To Quin, a 29-year-old Houston Lighting & Power communications consultant, that made plenty of sense, so he switched to Yacktman Focused. "I'm essentially hiring somebody to pick stocks for me," Quin observes. "He's got 10 or 15 great ideas, sure, but does he really have 150?"
The fund industry is betting more investors will see things Quin's way. Besides Yacktman, other high-profile fund boutiques, including Ken Heebner's Capital Growth Management, have opened so-called focused or concentrated funds. Additional funds are on the way: Globalt, which already runs a "20 best" portfolio for institutions, is mulling over one for individuals, while Tom Marsico, who last summer quit as manager of Janus Twenty, has filed papers to open Marsico Focus in January.
NOTHING SURE-FIRE. Should you pay attention? Perhaps, but be careful, because there's nothing sure-fire about focused investing. For one thing, some highly diversified mutual funds with large portfolios, such as Brandywine (with 287 stocks) or Tweedy, Browne American Value (with 169) have performed smartly with a diametrically opposed strategy. In addition, the fewer stocks in a portfolio, the less diversification and the greater volatility. And chances are, a concentrated fund's returns will be less tied to the overall market's.
Some older focused funds, however, have been long-term winners, notably 27-year-old Sequoia, whose 14-stock portfolio is run by Warren Buffett cronies Bill Ruane and Rick Cunniff. Yet the four Steadman funds, none with more than 22 stocks, all have proved persistent losers.
On average, diversified U.S. equity funds holding 25 or fewer stocks have persistently produced below-average returns at above-average risk, a search of the Morningstar Principia data base found. "The risk is picking the wrong manager," says New York University finance professor Martin Gruber, who has studied mutual funds and portfolio diversification.
Still, if you're not a die-hard index-fund investor and believe that active stock picking is worth the extra expense it entails, there may be a place in your portfolio for a concentrated fund. The key thing, says Gruber, is feeling you can pick a winning money manager: "The more confident you are, the more chips you should put there."
UNIVERSE. To help you find the best managers running concentrated funds, we surveyed Morningstar's universe of 2,523 domestic stock funds. First, we limited the field by putting a ceiling of 25 on the number of fund holdings. That knocked out all but 46, including even the popular Neuberger & Berman Focus, which despite its name holds 47 positions. Next, we passed over those, such as Sequoia, that have been closed to new investment and others that charge loads or demand initial stakes of more than $10,000. In the end, we settled on three with good records over at least the past five years, and five less seasoned yet promising funds (table).
Among the established mutual funds, Clipper's Jim Gipson and Michael Sandler have prospered by concentrating on large stocks, particularly financials such as Freddie Mac, which at last report made up more than 10% of Clipper's portfolio. Other big holdings include Wal-Mart Stores, McDonald's, and Mattel.
At Janus Twenty, the largest fund of the group with $6.1 billion in assets, investors who grew to love Marsico must now decide whether they can get comfortable with his successor, Scott Schoelzel (box).
With less than $400 million in assets despite five years of superior performance, White Oak Growth is the group's sleeper. Manager Jim Oelschlager's portfolio is heavily weighted toward technology. "What's happening in tech is like another industrial revolution," he says. He likes Cisco Systems, the fund's top holding at more than 5%.
Other companies on Oelschlager's list include Cisco competitor Ascend Communications and Citicorp, which he sees partly as a tech play. Banks that have invested heavily in the technology to deliver services more efficiently will grow at the expense of those that haven't, he believes.
SCARY YEARS. Each of the newer focused funds in the table comes with a pedigree. Heebner has steered his CGM Capital Development (now closed) to an annual average total return of 25% over the past five years, vs. 19% for the average fund. But he has nonetheless suffered some scary years. In 1994, CGM Capital Development lost nearly 23%, and he cautions that new investors in CGM Focus should be willing to tie up their money for, say, five years, a rule that applies to every focused fund.
Besides making big bets, which he now has placed on oil-services stocks such as Tubos de Acero de Mexico and on wallboard maker USG, Heebner is known for trading frequently, turning over an entire portfolio every six to nine months. Focus takes a different approach. Run by Robert Hagstrom, author of the 1994 book The Warren Buffett Way, the fund emulates Buffett's long-term style and, not incidentally, his portfolio: Hagstrom has lots of chips on such Buffett favorites as American Express and Walt Disney.
To date, that hasn't made Focus investors rich. Last year's total return came to 17.1%, more than two percentage points less than its peers, in part because of its relatively steep 2% expense ratio. Its low turnover, however, so far has given Focus a leg up by realizing fewer capital gains and limiting investors' tax bill.
Oakmark Select is managed not by Robert Sanborn, whose Oakmark fund has returned an annual average of 25% in the past five years, but by Oakmark's research director, William Nygren. Like Heebner, Nygren sees value in USG. In addition, he has had as much as 15% of the fund in cable TV stock Tele-Communications Liberty Media Class A.
Pilgrim Baxter & Associates, known for its "momentum" style of growth-stock investing, runs PBHG Large Cap 20. Manager Jim McCall has had a quick start with tech stock picks such as Dell Computer and PeopleSoft.
You won't find many momentum stocks in the eclectic portfolios managed by Yacktman, but that hasn't slowed him down: His flagship fund's average annual total return over the past three years outdid its midsize stock benchmark by seven percentage points. In Yacktman Focused, he has invested up to one-fifth of the fund's assets in tchotchke distributor Department 56, another 18% chunk in cigarette maker Philip Morris, and more on the likes of Reebok International and Fruit of the Loom.
Dave Quin knows a portfolio that's concentrated in a few stocks such as these will be volatile, but he is betting squarely on Yacktman Focused. "The more diversified you get, the more you'll wind up closer to the average," he explains. "If I want average, I can invest in an index fund." So far, Quin is winning his wager: In the third quarter, Yacktman Focused beat Yacktman, 9% to 7.7%.By Robert Barker EDITED BY AMY DUNKINReturn to top