ClearBridge Fund Best as Patience Pays: Riskless Return
ClearBridge Investments’ Richard Freeman followed drug company Alza Corp. for 28 years before buying shares in 1999, when a failed acquisition by a larger company sent shares plunging. Two years later, Johnson & Johnson bought Alza for triple the price the fund paid.
Patience and a contrarian view helped Freeman and co-manager Evan Bauman steer Legg Mason Inc. (LM)’s $7.6 billion ClearBridge Aggressive Growth Fund to a risk-adjusted performance of 4.3 percent over the past three years, the best of 34 large funds that buy stocks of U.S. companies with higher-than-average growth, according to the BLOOMBERG RISKLESS RETURN RANKING. The ClearBridge fund returned 45 percent after price swings since it started in 1983, the highest among the six peer funds that have been in existence since then.
Freeman and Bauman, who seek cash-rich companies that are growing faster than their rivals, wait to buy their targets at what they deem is the right price and generally hold on to their picks for years. The managers don’t pay much attention to the composition of the fund’s benchmark, the Russell 3000 Growth Index, instead focusing on companies and industries with the best prospects for growth. The fund has put 34 percent of assets into health-care stocks, almost three times as much as the allocation in the benchmark.
“Over the last three years, the performance has been from many names put into the portfolio 10, 20 and 25 years ago,” Freeman, 60, who has run the fund since its inception, said in an interview from his office in New York. “The strongest names are those we’ve owned for a long time and have gone on to make higher highs in terms of earnings and cash flows, and stock prices have moved accordingly.”
Legg Mason carved out ClearBridge from stock funds it acquired with its 2005 purchase of Citigroup Inc.’s (C) asset-management unit. ClearBridge, now the Baltimore-based money manager’s largest equity-fund affiliate, in January took over the Legg Mason Capital Management division formerly home to stockpicker Bill Miller.
Performance at the Aggressive Growth and other funds has helped ClearBridge attract money this year, as Legg Mason has struggled to reverse five straight years of net redemptions. Chief Executive Officer Joseph A. Sullivan, who was named to the role in February, has vowed to stem withdrawals by focusing on Legg Mason’s product lineup and improving performance.
ClearBridge Aggressive Growth Fund’s No. 1 ranking was driven by the highest absolute return of 85 percent, which helped mitigate the impact of above-average volatility. The fund’s volatility was 19.9, compared with 19.2 for the group.
The ranking included funds with assets of more than $1 billion and in operation for at least three years within a group defined by Bloomberg as growth stocks.
The $1.9 billion Delaware U.S. Growth Fund had the second-highest risk-adjusted return, at 4.1 percent, followed by the $1 billion Delaware Select Growth Fund (DVEAX), which had a 4 percent return when adjusted for price swings. The funds have similar management teams and both posted higher returns than peers with below-average volatility.
The risk-adjusted return isn’t annualized. It’s calculated by dividing total return by volatility, or the degree of daily price variation, giving a measure of income per unit of risk. Higher volatility means the price of an asset can swing dramatically in a short period, increasing the potential for unexpected losses.
The ClearBridge fund’s concentration in biotechnology stocks may lead to higher price swings, according to Freeman. Biotechnology stocks tend to be more volatile because of “binary outcomes,” which the managers seek to address by focusing on more diversified companies that produce several drugs for a variety of incurable diseases, Bauman said. The Nasdaq Biotechnology Index had volatility of 21.4 over the past three years, compared with 17.7 for the Russell 3000 Growth Index, according to data compiled by Bloomberg.
Freeman and Bauman have also sought to minimize volatility by holding onto stocks for long periods of time and keeping turnover to the single digits. The fund’s turnover ratio, a gauge of how much the holdings change in a year, was 8 percent, compared with an average of 96 percent for the 520 funds classified as multi-cap growth funds by S&P Capital IQ, according to Todd Rosenbluth, director of mutual fund and ETF research for the McGraw Hill Financial Inc. unit.
The ClearBridge managers have been able to boost returns by picking companies that have positive free cash flow and have been able to increase earnings by introducing innovative products. The compound five-year growth rate in operating income for Biogen Idec Inc. (BIIB), the fund’s largest holding, was 10 percent. That rate was 29 percent for the second-biggest holding, UnitedHealth Group Inc. (UNH), according to data compiled by Bloomberg.
Biogen, which develops drugs for neurological disorders, cancer and arthritis, has been a stake since 1991, when it traded for less than $3. The shares surged to $206.55 as of Aug. 20.
UnitedHealth Group, which was also bought in 1991, now represents about 7.6 percent of the fund. UnitedHealth, the largest U.S. health insurer, has returned 139 percent over the past three years. Health-care stocks have benefited as investors have sought out quality companies and regulatory reform means more Americans will have insurance, said Rosenbluth of S&P Capital IQ.
Freeman and Bauman decided to increase shares of Facebook Inc. in August 2012, when the world’s most popular social-networking company was trading in the low $20s. The shares have since surged to $38.41. The fund held about 2.45 million shares of Menlo Park, California-based Facebook, accounting for about 0.8 percent of the fund as of June 30.
The managers liked Facebook’s appeal among users and strong balance sheet, and bought as shares dropped about 45 percent from the initial public offering.
The emphasis on growth hasn’t prompted the ClearBridge managers to overlook the importance of investing in stocks at the right price. Freeman avoided technology stocks in the late 1990s, prior to their 37 percent plunge in 2000.
“It’s the most plain vanilla strategy in the world -- make good entry points on valuation, and hold onto them for the long term,” said Shannon Zimmerman, associate director of fund analysis for Chicago-based research firm Morningstar Inc. (MORN) “They’re bottom up, fundamental stock pickers who know their companies inside and out.”
The ClearBridge fund’s retail share class attracted $163 million this year through June 30, the third-highest flows among ClearBridge’s 15 U.S. mutual funds, according to estimates from Morningstar. The offshore version of ClearBridge Aggressive Growth Fund (SHRAX) lured more than $500 million from institutional investors in Europe and Asia this year, said Bauman, who has helped manage that version of the fund since 2000.
ClearBridge attracted $2.6 billion during the three months ended June 30, helping Legg Mason limit equity withdrawals to $700 million, the smallest amount since 2010.
Investors in the ClearBridge Aggressive Growth Fund should be aware there is potential that the fund may have more money than it can focus on as it continues to attract deposits and take concentrated positions in smaller companies, Morningstar’s Zimmerman said. The weighted average market capitalization of the fund is $36.4 billion as of July 31, according to ClearBridge’s website, compared with $80.3 billion for the Russell 3000 Growth Index.
Freeman said he isn’t worried about liquidity of the companies the fund invests in and similar strategies handle as much as $60 billion in assets.
The ClearBridge fund advanced 23 percent over the past three years on an absolute basis, beating 98 percent of similarly managed rivals, according to data compiled by Bloomberg. The fund returned 25 percent this year, beating 96 percent of peers.
Freeman, who at the age of 13 would sit in a local brokerage firm after school to watch the ticker, said Alza piqued his interest because it was the first company dedicated to the sustained release of drugs, by delivering smaller doses of medication at set intervals.
He bought 2.2 million shares of Alza in December 1999, when shares fell more than 30 percent after an acquisition by Abbott Laboratories fell apart amid concerns raised by the U.S. Federal Trade Commission. Johnson & Johnson acquired Alza in June 2001 for triple the price paid by the fund, as the health-care company sought to spur growth in its prescription-drug business. Freeman exchanged Alza shares for Johnson & Johnson stock, and held onto them for an additional seven years, a period in which the shares returned 48 percent.
“The most important thing is do we think companies can make higher highs in terms of earnings and cash flows,” said Freeman. “Because there’s going to be a correlation over time between earnings and stock price.”
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