When Barry Ogden took over the Waddell & Reed Advisors Tax Managed Equity Fund/A (WTEAX) in January, 2002, he unloaded stocks that incurred big losses following the popping of the tech bubble.
By October of that year the fund had lost 39.4% of its value, in line with its large-cap growth peers, which plunged 53.4% on average. The S&P 500, the fund's benchmark, shed 43.7% over the same period.
ONCE A WEEK. However, the $67.2 million fund, now ranked 5 Stars by Standard & Poor's, has since recovered. For the three years ended July 29, it registered an annualized return of 13%, vs. 10.6% for its peers and 12.6% for the S&P 500. For the one-year period ended July 29, 2005, the fund gained 19%, vs. 14.1% and 14%, respectively.
The fund's standard deviation, a measure of volatility, is 10.97%, well below its peers' 13.95% average. Its expense ratio of 1.4% is comparable to the peer average of 1.44%.
Carol Wood of Standard & Poor's Fund Advisor spoke recently with Ogden about his investing strategy. Here are edited excerpts of their conversation:
Can you describe your investment philosophy?
It's a blended, bottom-up/top-down approach. We have a group of about 20 to 25 analysts who help the fund managers on a daily basis. The managers get together once a week to talk about ideas on a macro or worldwide basis. We do individual research, go see companies, and go to conferences.
But at the end of the day, I'm more focused on identifying stocks that are going to outperform the market over the next 6 to 12 months at a minimum.
What's your strategy?
We have no hard and fast buy/sell criteria -- there's no list I go through on a daily basis. Our method involves a variety of factors. For example, is this company growing its top line? As a growth company, it needs a strong balance sheet and good operating and free cash flow to be able to finance that growth.
Most of my companies' top lines are growing in excess of 8%. They've got margin expansion, operating income is growing at 15% to 20%, and earnings per share is climbing 20% to 25% -- thus, they're getting leverage throughout the income statement.
How do you define "growth"?
I'm not necessarily looking at trailing price-to-earnings ratios -- I'm trying to look forward. What is the true earnings power of this company over the next two to three years? How much higher is that than current Wall Street consensus estimates?
Do you buy only large-cap stocks?
Our mandate says it's large-cap growth. Right now that threshold is at about $12 billion to $13 billion, so I must keep 75% of my assets in companies with a market cap greater than that. I can have 25% or so in both small- and mid-cap names.
How do you manage risk?
Largely through the number of holdings we keep. Typically, the fund comprises about 75 to 85 names -- more than 100 is too many to monitor. With fewer than 50, I think a fund can become too concentrated.
Can you explain the "tax managed" elements of the fund?
It's a long-term, buy-and-hold strategy. My turnover in the last two-and-a-half years has been well under 100%. When I took over the fund, we restructured the portfolio and sold a lot of names that incurred pretty significant losses. We built up a capital loss carry-forward that has protected our shareholders quite nicely over the last three years and should protect them throughout the rest of this year.
How are you making money off these stocks and not having to pay taxes?
In the best-case scenario, I make a lot of money for my shareholders through market appreciation and capital appreciation. But at some point, somebody is going to have to pay taxes when we sell. My shareholders don't want me to hold onto something that goes down significantly in value to avoid paying capital gains.
Do you have favorite sectors?
Health care represents our heaviest sector weighting by far. Energy and technology are also overweighted, while we are underweight in financials.
When I was an analyst, my area of expertise was in health care, and I may have a competitive advantage over some of my peers in that sector.
Is health care a defensive position for you?
No, I have a lot of exposure to biotechnology, generic drugs, and health-care service areas like managed care and some hospitals. I'm underweighted in the defensive sectors of health care, like large-cap pharmaceuticals.
Energy is a "growth" sector, because it participates in a growing economy?
Energy is more thematic for me. One of the reasons I like energy is that there are long-term supply/demand imbalances. Supply simply is not growing at the same rate as demand. The clearing mechanism is going to be price. There will be a supply-and-demand response from higher prices.
The energy companies that I have are going to make a ton of money between now and then. Some of my top energy names include Patterson-UTI Energy (PTEN), Apache (APA), Burlington Resources (BR), Exxon Mobil (XOM), and Anadarko Petroleum (APC).
Can you single out a holding and discuss how it reflects your investment style?
We're building a position in Walgreen (WAG), the leading drug retailer in the country. Walgreen has good square-footage growth, and they are increasing their comparable-store sales. Also, their gross margins and operating margins are expanding. They should be able to grow their earnings 15% to 20% annually for the next two to three years.
This company is going to benefit as more people trade out of branded pharmaceuticals into generic drugs. So I'm almost thinking of Walgreen as part of my health-care exposure.
To what do you attribute the fund's recent outperformance?
It has probably been driven by our energy exposure, as well as the quality health-care names we have, especially within managed care, biotechnology, and some medical-technology stocks such as St. Jude Medical (STJ).
Do you have an overall outlook for the market?
It has done better than I would have thought, given that energy prices have gone up so much this year. And with the Fed raising rates, I would have thought these factors would serve as headwinds.
With respect to returns, the fund is only about 2% above the S&P 500, but since April we've had a very nice move. For the second half of the year, we'll probably be plus or minus 5% relative to the index. I'm not making any big calls either way, but I think there is still a lot of opportunity to find good names that will outperform.
Are large-cap growth stocks the "new small-cap stocks" -- that is, are they poised to see rapid appreciation in the near term?
I think large-cap growth could be a sector that does well. It has been the worst-performing category for the last five years. The 20-year chart shows that no one class is best or worst for more than five years. So If history is any indicator....