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SunAmerica Value Finds a Bigger Focus

Steve Neimeth took over managing the SunAmerica Value Fund (SSVAX) in late August, when AIG SunAmerica Asset Management replaced American Century as the fund's investment adviser. Neimeth shifted the portfolio from a mid-cap style to a higher quality, large-cap orientation that he felt would outperform as interest rates rise.

This year through October, the fund gained 7.3%, while its large-cap value peers returned 4.3%. For the three-year period through last month, the fund rose 10.4% annualized, vs. a 5.4% gain by its peers. Based on risk-and-return characteristics over the last three years, Standard & Poor's gives the fund its highest rank of 5 STARS.

Palash Ghosh of Standard & Poor's Fund Advisor spoke recently with Neimeth about the fund's investing strategy and top holdings. Here are edited excerpts of their conversation:

Q: What changes did you make in the fund when you became manager?

A: We decided to emphasize higher quality, large-cap companies since interest rates are likely to rise for the next two or three years. We boosted the fund's average market cap to $100 billion, from about $23 billion. We overhauled about 75% of the fund by unloading several mid-cap stocks.

Q: What's your investment philosophy? What are your specific buy criteria?

A: Our stock picking is strictly bottom-up. We buy companies that are trading at a p-e below the market's average multiple -- but with an earnings/revenue growth rate that's equal to or above the market average.

We evaluate a company's intrinsic value based on its balance sheet, cash flow, and accounting. We like stocks with low debt-to-capitalization ratios, high free cash flows, and clean accounting.

Q: What are your largest holdings?

A: As of Oct. 30: General Electric (GE), 5%; ChevronTexaco (CVX), 4.2%; Exxon Mobil (XOM), 4.1%; Bank of America (BAC), 4.1%; Citigroup (C), 3.7%; American Express (AXP), 3%; J.P. Morgan Chase & Co. (JPM), 2.5%; United Technologies (UTX), 2.3%; Marathon Oil (MRO), 2.2%; and Limited Brands (LTD), 2.2%.

These 10 holdings represent 33.3% of total assets. We typically hold 45 to 55 stocks and currently have 51 holdings.

Q: Can you discuss two recent purchases?

A: Limited Brands, which has performed very well this year, is a women's intimate-apparel and personal-care-products retailer that we bought at about $20 per share just after we took over the fund. The stock didn't look that inexpensive as it was trading at a p-e of 16, similar to the market multiple, but Wall Street didn't seem to recognize the company's strong balance sheet. Limited Brands had $4 per share in cash on the balance sheet and was generating $500 million annually in free cash flow, representing a 5% yield on the market capitalization.

In addition, the company was returning cash to shareholders. They bought back $1 billion in stock through a Dutch tender offer in March, 2004, and plan to repurchase $2 billion this year, for a total buyback of about 30% of shares outstanding.

United Technologies, which provides technology products and services to the building-systems and aerospace industries, is another stock that was trading at a slight discount to the market but also had a strong balance sheet overlooked by investors. Over the past four years, the company's margins and balance sheets have significantly improved. In addition, UTX is a strong free cash flow generator. Having a solid balance sheet, the company can easily repurchase shares or enhance growth through acquisitions.

Q: What are your top sectors?

A: At the end of October: Finance, 31.1%; industrial and commercial, 14%; energy, 10.6%; information technology, 8.8%; consumer staples, 8.7%; consumer discretionary, 7%; information and entertainment, 6.7%; utilities, 5.6%; materials, 3.8%; and health care, 2.9%.

Q: Your largest sector is finance. Are you concerned about rising interest rates impacting those stocks?

A: We're currently underweighting financials relative to our benchmark in light of higher interest rates. Within financials, we're focusing on large-cap, diversified financial institutions like Bank of America, Citigroup, and American Express, as they tend to outperform when rates tighten. We've avoided financial companies with heavy mortgage exposure.

We also own a number of brokerages, including Merrill Lynch (MER) and Goldman Sachs Group (GS), because they have attractive price-to-book values. This subsector should benefit from growth in banking and equity trading.

Q: Given historically high oil prices, have you been adding to your energy holdings?

A: We're underweight in energy since we're cautious on the sector. We think oil prices will continue to decline due to easing tensions in the Middle East and reduced speculation in the futures market. We own oil stocks like ChevronTexaco, Exxon Mobil, and Marathon, but we don't own oil drillers, as they're expensive and highly volatile. Our energy stocks tend to be stable, diversified large-caps, which can provide strong earnings growth.

Q: Relative to the benchmark, what sectors are you overweighting?

A: We're overweighted in industrials and consumer discretionary. When the economy starts to recover and interest rates are rising, late-cycle industrial stocks tend to outperform early-cycle names, which have already appreciated.

Our late-cycle holdings, such as United Technologies, Tyco (TYC), General Dynamics (GD), and Honeywell (HON), tend to possess stable earnings/revenue streams and less volatility.

With consumer discretionary stocks, we have taken a somewhat contrarian view. Many observers point to high valuations and slowing consumer spending, but we like many consumer discretionary stocks because of their improving balance sheets. Some of our favorite holdings in the sector include Limited Brands, Harrah's Entertainment (HET), Home Depot (HD), and Wendy`s International (WEN).

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