Parnassus Beats 95% of Peers as Top Funds Are Bullish on 2011
For Jerome Dodson at Parnassus Investments, growing public pessimism about the economy in 2010 convinced him to purchase stocks. Allianz RCM Technology Fund’s Walter Price ruled out a recession after executives told him business was improving. At Columbia Management Investment Advisers LLC, Tom Galvin said record cash made equities impossible to pass up.
Unemployment close to 10 percent and falling home sales failed to deter the best-performing U.S. fund managers this year, handing them average gains of 28 percent, data compiled by Bloomberg show. They’re bullish on 2011, boosting stakes in oil producers, temporary-help providers and Internet companies.
“When everybody’s depressed is absolutely the best time to buy stock,” said Dodson, who oversees $4.5 billion as president of Parnassus in San Francisco. “Everyone was moaning and groaning this summer. At that time, had you been able to divorce yourself from your emotions and buy stocks, it would have been great. You just have to buy, and that’s what we did.”
Dodson, Galvin, Francis Claro at Wells Capital Management Inc., Dennis Lynch at Morgan Stanley and Whitney George at Royce & Associates LLC all beat 92 percent of their peers by holding 50 percent more in industrial and consumer stocks, the best- performing groups in 2010, than are represented in the Standard & Poor’s 500 Index. Price, who invests mostly in technology providers, returned 30 percent to his investors, boosted by a 52 percent rally in Apple Inc. and a 97 percent gain in business- software supplier Salesforce.com Inc.
The best money managers were buyers even as unemployment, which held close to the highest level since 1983, sent the S&P 500 to a 2010 low of 1,022.58 in July. Dodson, Price and Galvin said they were betting earnings growth, rising cash balances and below-average valuations would keep the bull market intact.
“This year has provided lots of re-entry opportunities,” said George, the New York-based co-chief investment officer at Royce and manager of the $4.2 billion Royce Low-Priced Stock Fund, which has returned 27 percent this year and is in the 99th percentile of its peers for the past five years. “Valuations are pretty good, fundamentals are pretty good. There are lots of things going on in the market that are positive.”
The S&P 500 trades for 15.3 times earnings, compared with an average 16.4 since 1954, according to data compiled by Bloomberg. The multiple has declined from a high of 18.8 in March as profits increased faster than share prices.
Mohamed El-Erian and Bill Gross at Pacific Investment Management Co. warned in 2009 that gains in equities and bonds would be below historical averages for years to come. El-Erian, co-chief investment officer of the Newport Beach, California, firm that oversees the world’s biggest bond mutual fund, said in June 2009 that investors should prepare for an environment of slower growth and lower returns, curbed by rising government deficits and regulation.
“We summarized this outlook by the phrase, ‘A bumpy journey to a new normal,’” El-Erian wrote in an e-mail to Bloomberg News last week. “We also are careful to specify more than one scenario. Indeed, the bumpy journey to a new normal scenario, while the most probable, has been given a 55 to 60 percent probability during the last 18 months. We have also detailed the specific characteristics and probabilities of three other scenarios that involve either a faster recovery or the risk of a double dip.”
U.S. equities have returned 6.2 percent a year since 1900 before dividends, according to inflation-adjusted data compiled by the London Business School and Credit Suisse Group AG in Zurich.
Stocks rose last week, pushing the S&P 500 up 3 percent to 1,224.71, after American retailers reported sales that beat analyst estimates, Chinese and European manufacturing expanded and policy makers extended an emergency loan program in Europe. An Institute for Supply Management report showed U.S. manufacturing expanded for a 16th month in November. The Labor Department said Dec. 3 that employers added 39,000 jobs in November, less than the most pessimistic projection of economists surveyed by Bloomberg News.
The S&P 500 lost 0.1 percent to 1,223.12 today after Federal Reserve Chairman Ben S. Bernanke said the world’s largest economy may need more stimulus.
Dodson, whose fund is ranked the third-best for diversified U.S. equities in Bloomberg data through Nov. 12, returned 28 percent this year. He bought companies from Finisar Corp., the Sunnyvale, California-based maker of fiber-optic networking equipment, to Administaff Inc., a human-resource services provider in Kingwood, Texas, speculating they will gain as the economy improves in 2011.
Claro of Wells said that signs unemployment had peaked were reasons to be optimistic in 2010. The proportion of American workers unable to find a job reached a 26-year high of 10.1 percent in October 2009 and has since fallen to 9.8 percent, according to Labor Department data.
“If you have this high unemployment rate, are we more likely to go to an 11 percent unemployment rate or are we more likely to go to an 8 percent rate or 7 percent rate, given time?” he said. “The higher you are in terms of some of these indicators, such as the unemployment rate, the more opportunity you could find.”
Claro bought shares of New York-based Monster Worldwide Inc., the world’s largest online recruiting company, as its shares surged 34 percent this year. The firm returned to profit in the third quarter and will make money all next year, according to average analyst estimates collected by Bloomberg.
Free Cash Flow
Lynch, head of growth investing at Morgan Stanley Investment Management Inc., said he looked for companies with the highest free cash flow yields, or income after capital spending divided by share price, that had the potential to boost earnings as the financial crisis abated. Internet-based companies, such as Norwark, Connecticut-based travel agency Priceline.com Inc., were among the best examples, he said.
“Our portfolio is full of strong companies that have strong balance sheets and sustainable competitive advantages,” said Lynch, whose $6 billion Morgan Stanley Institutional Fund Trust Mid Cap Growth Fund has returned 31 percent this year, better than 96 percent of peers.
The S&P 500 is up 21 percent from its 2010 low in July including dividends. Its total return since Dec. 31 of 12 percent also beat investment-grade corporate bonds, which returned 9.5 percent since the start of the year. Treasuries have underperformed both, with a 2010 return of 6.9 percent, according to Bank of America Merrill Lynch indexes.
Citrix Systems Inc., a Fort Lauderdale, Florida-based software developer that Price added to his $1.17 billion Allianz RCM Technology Fund, is up 67 percent year-to-date, the third- biggest increase among technology stocks in the S&P 500. RCM Tech rose 30 percent this year, in the 95th percentile.
“Late in the first quarter we started buying to be a more aggressive portfolio,” Price said. “We were hearing a lot of concern about a double dip, but actually business was pretty good as we saw with third-quarter reports. It was like we read the headlines and we saw the concerns, but we also heard a lot of our companies telling us, ‘No, business is fine.’ So we didn’t panic out of our core holdings.”
S&P 500 companies hold about 10.6 percent of their market value in cash, with the third quarter marking the eighth straight period of record corporate reserves, according to estimates and data from Howard Silverblatt, the senior index analyst at S&P. Executives are posting better-than-forecast earnings, with more than 70 percent of S&P 500 companies beating estimates this quarter.
That’s the sixth straight period in which more than 70 percent exceeded forecasts, the longest stretch since at least 1993, data compiled by Bloomberg show. The U.S. economy is projected to expand 2.5 percent in 2011 and 3 percent in 2012, according to 63 economists surveyed by Bloomberg.
“We invest in high-quality, high-growth companies and they are particularly well-positioned today -- maybe better than any time in the past 10 years -- because they have the best balance sheets in a world where cash is king,” said Stanford, Connecticut-based Galvin, whose $3.5 billion fund beat 98 percent of peers this year. “You need to have strong balance sheets to invest in new developments and bring to market new products that are gaining market share even in an economy that’s showing little lift.”
Mutual funds investing in U.S. equities have seen outflows every week since the start of May, totaling more than $80 billion, according to data and estimates compiled by the Washington-based Investment Company Institute. Professional investors also were wary, as futures on the Chicago Board Options Exchange Volatility Index showed in September that concern stocks would plunge had never been higher.
To Dodson at Parnassus, Royce’s George and Claro at Wells Capital Management, negative sentiment was a contrarian signal that provided the initiative to buy. Dips in equity prices provided opportunities to acquire stocks at below-average valuations and wait for bearish investors to change their minds.
“This summer, when people started to worry about a double- dip recession, one of the areas that was most aggressively sold was technology stocks, and so we added some semiconductors,” George said. “We’re value investors and contrarians. When you have a lot of negative press and people worrying about the market, you tend to get better valuations in stocks.”
George said he bought Fairchild Semiconductor International Inc. as the S&P 500 was declining 16 percent between April and July. The South Portland, Maine-based maker of chips that convert and regulate power in electronic devices is up 81 percent since July 2 and has posted nine consecutive quarters of better-than-projected earnings, according to Bloomberg data.
“People focused on: Is the company doing well and growing fast? And if the answer was, ‘Yes,’ they bought the stock,” San Francisco-based Price said. “It wasn’t this macro theme overwhelming everything like it was the last two years. That’s a great development. If we navigate this environment and the economy continues to improve, stocks will work their way higher in 2011.”
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