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A Fund That Rides on Rising Stars

Carl Marker, the manager of IMS Capital Value Fund (IMSCX), looks for value stocks that are gaining momentum so he doesn't have to wait too long for them to rebound. He says he takes this approach because turnaround companies often take at least two years to resolve their problems.

The fund manager searches for promising investments in the sectors he says have been the most profitable for the last 50 years. These are health care, technology, finance, consumer staples, and communications. To reduce risk, he avoids large-sector bets and holds 40 to 60 stocks. Volatility is moderate, and the fund's three-year

standard deviation is 18.1%, vs. 17.5% for the peer group.

Marker has shifted the fund's strategy from purely value to a mix of value and momentum in 2000. For the three years through last year, the portfolio rose 18.1% on average per year, compared with 4.8% for the S&P 400 Mid-Cap Index. This year through May 14, the fund was up 2.3%, while the index fell 2.0%.

Based on risk and return characteristics during the last three years, Standard & Poor's gives the fund its highest overall rank of 5 Stars. Bill Gerdes of S&P's Fund Advisor spoke recently with Marker about his strategy. Edited excerpts from their conversation follow:

Q: What's your basic investment philosophy?

A: We invest in mid-cap stocks that combine value and momentum characteristics. We like mid-cap stocks because they offer the liquidity and proven managements of large-cap companies with the growth and nimbleness of small companies. We like seasoned companies that are turning around when their stock prices are cheap. They have time to right the ship.

Q: How do you combine value and momentum in deciding on investments?

A: Our process starts with value. Once we have narrowed our universe to undervalued companies that are turning around, we look for momentum in their stock prices to determine when to buy. Momentum is definitely secondary, but it helps us determine our entry point into a stock.

Q: Why do you wait to invest in a company when they're turning around?

A: We try to avoid getting into a stock too early and sitting on dead money. Once companies lose value, about 80% will underperform for a minimum of two years while they work through their problems.

Q: Do you focus on certain sectors for turnaround investments?

A: We don't look at it in terms of sectors, but there are some sectors where more money is made over time than in other sectors. Over the last 50 years, more money has been made in health care, technology, finance, consumer staples, and communications, so we want to be in those areas.

We try to stay in the fast-moving streams, so we practice concentrated diversification. We avoid any large sector bets and make sure our holdings are diversified. At any given time, we'll be in the 10 largest sectors of the S&P 500. We now have about 50 holdings, which is in the middle of our range of 40 to 60 holdings.

Q: Do you have a minimum or maximum weighting for a holding?

A: We start with a 2% position and will reduce it if it gets above 10%. Tyson Foods (TSN), our largest holding, is now about 6.5%, and Service Corp. International (SRV), our second-largest holding, is 4.5%. Tyson Foods is a play on changing dietary habits, as people eat more protein. Service Corp. International, the largest provider of funeral services in the world, has earnings momentum and is aggressively reducing its debt. They also have aging demographics in their favor.

Q: Although the fund's returns have been strong each year since 1999, why were they less competitive in 2000, despite being higher than the peer-group average?

A: Lower p-e tech holdings, such as Novell (NOVL), Semtech (SMTC), and Intuit (INTU) hurt us relative to our peers in 2000. Also, we had begun to add momentum to our process in 1998, and 2000 was the last year of that transition. But combining momentum with value over the last four years has helped us relative to our peers.

Q: What have been some of the major changes in the fund in the past year?

A: There haven't been any major changes. Our median market capitalization -- $4.3 billion as of Mar. 31 -- has stayed constant, between $3 billion and $5 billion. A year ago, our largest holding was Marvel Enterprises (MVL), which we've reduced, although it's still a large holding. We felt that Marvel had lost a lot of momentum.

Q: Do you have any favorite stocks?

A: Along with Tyson Foods and Service Corp. International, my other favorite holding is E*Trade Financial (ET), which is the most innovative financial-service company. They're doing things that no other finance company is doing, such as rebating part of the 12b-1 fees they receive back to their customers.

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