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Temporary Trouble Can Be Rewarding

Because stable, industry-leading stocks aren't often attractively priced, those facing temporary setbacks often present the best opportunities, says Scott Moore, manager of American Century Value/Inv (TWVLX). To enhance the risk rewards of these kinds of investments, Moore and the fund's other managers, Phillip Davidson and Michael Liss, search across the market-cap spectrum for potential holdings.

Moore feels the current market is less attractively priced overall because of its recent run-up, but he has found some opportunities due to high energy prices, such as Union Pacific (UNP).

To lessen the downsides of investing in troubled companies, Moore likes to trade around positions rather than buying or selling outright. This strategy may have resulted in a relatively high turnover of 100% to 130%, but the fund's volatility is still moderately low, with a three-year

standard deviation of 14.85%, relative to the Standard & Poor's 500-stock index, at 16.51%.

The fund's cautious approach to investing in beaten-down companies has held up over the long term. For the three-year period through last month, American Century rose 7.2%, on average, compared with a 2.1% loss for the S&P 500. For the one-year period through May, it was up 21.8%, vs. a 18.3% rise for the S&P 500.

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 Moore about his strategy. Edited excerpts from their conversation follow:

Q: What's the fund's basic investment strategy?

A: It's a classic value fund, searching for high-quality stocks with transitory problems resulting in low price-earnings ratios. The underlying companies are No. 1 or No. 2 in their areas. We look across the market-cap spectrum for ideas, although we generally consider companies with market capitalizations of $1 billion and above. The fund's median market cap is about $9 billion.

Q: Why do you consider stocks of all market capitalizations?

A: We feel strongly that our analysts and managers have industry expertise that isn't limited to small, medium, or large companies. It wouldn't make sense for us to avoid those opportunities, since it's not easy to find companies with attractive risk rewards.

Q: Would you describe some recent transitory problems that have led to opportunities for the fund?

A: With fuel prices at historic highs, we've started to see several companies face cost pressures, which have impacted stock valuations. One of our top 10 holdings is Union Pacific (UNP). It has had fuel-cost difficulties, but it has a dominant position in the West Coast.

Q: Are there currently more or fewer undervalued investment opportunities than in the past?

A: The market is less undervalued overall now than usual. It has come off some lows, so we don't see the outsized returns like before.

Q: What are your largest sector overweightings?

A: Our largest overweighting is in the broad industrial space, including railroads. We also have small overweightings in aerospace, defense, construction, and engineering. A typical holding is Martin Marietta Materials (MLM), a road construction company that's facing pressures from state government cutbacks on road building.

Q: Did you overweight these sectors due to potentially higher economic growth?

A: Our baseline assumption is for a moderately growing economy. Most of our holdings are likely to grow along with the economy. But if the economy underperforms, then some of these stocks may underperform, leading to attractive stock-buying opportunities.

Q: The fund appears less volatile than its peers. Do you take steps to limit volatility?

A: We aim for less volatility than our peers. We try to limit volatility by trading around positions rather than completely trading in and out of stocks. Our stated turnover is about 100% to 130%, but our stock turnover is about 50%. We look for good companies -- all things being equal, we want higher weightings in companies with the least downsides.

Q: What are the fund's largest holdings?

A: Union Pacific, SunTrust Banks (STI), Royal Dutch Petroleum (RD), Kraft Foods (KFT), Martin Marietta Materials, and Exxon Mobil (XOM). SunTrust is a top-tier regional bank with a reasonable dividend yield.

Q: Do you still own Marsh & McLennan (MMC)?

A: We're positive about them. Their insurance and consulting operations, which make up about 75% of their businesses, are top-tier. We think the risks related to their Putnam Investments unit are overblown and are likely to be behind them next year.

Q: Why have the fund's long-term returns been attractive?

A: We've been able to forecast when the consumer cycles weren't offering many risk rewards. Kimberly-Clark (KMB) is an example of what we've been able to do. Previously, it faced difficulties from high pulp prices and competition from Procter & Gamble (PG). We did well with Kimberly-Clark after it resolved its transitory issues.

Q: Why was 1999 a difficult year for the fund relative to its peers?

A: It was a big growth year, with the tech and Internet boom. No one cared about anything else at that point. We didn't get caught up in that phenomenon.

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