By James A. Anderson
As last year's fourth quarter began, tech stocks were hit by a cyclone. Investors were sucked into a downward cycle of taking profits or cutting their losses. Mutual funds with high concentrations in technology found themselves pummeled. So if you happened to be the manager of something called Buffalo USA Global fund (BUFGX ) and you had historically carried a 40% weighting in tech, you probably wanted to get out ahead of the thundering herd, right?
Well, not exactly. The fund stood its ground even as semiconductor stocks, networking shares, and other tech stalwarts fizzled in 2000. For portfolio manager Tom Laming, that has meant holding on to companies such as Cisco Systems and Agilent even as much of the tech market crumbled around them.
PRESCRIPTION FOR GROWTH.
Laming hasn't turned and run primarily because the tech meltdown has yet to make life miserable in the offices of Kornitzer Capital Management, the fund's nerve center in Shawnee Mission, Kan. For 2000, for instance, the Buffalo fund rose 8.8%, a total return that placed it in the top 5% of Morningstar's large-blend fund category for the year. The large-blend grouping includes portfolios that mix growth and value criteria when selecting large-cap stocks.
Buffalo USA has weathered the tech correction in large part because of its substantial positions in pharmaceutical companies, which make up nearly 18% of its portfolio. Another cushion has been the fund's stake in insurers, including American International Group (AIG) and AFLAC, both of which have been on a tear this year. Schering-Plough, which accounts for 4.3% of the fund, posted a total return of 35.6% in 2000. AIG, which accounts for 4.7% of Buffalo USA Global's assets, returned 37%, while AFLAC, at 4.1% of the fund, returned investors 54% in 2000. Those big increases offset losses in stocks such as Intel, Cisco, Microsoft, and Applied Materials.
Even though Buffalo Global joined the ranks of Business Week Online's exclusive list of A-rated funds only in November, it has fared well for the half a decade or so it has been in existence. Over the past 12 months, the fund's total return of 14.7% outstripped that of 97% of its direct competitors. Its average annual total return of 18.3% over the past three years, and 21% over the past five, have placed Buffalo Global in the top 8% and 7%, respectively, of the large-blend group.
SEEN IT ALL BEFORE.
Buffalo USA has produced such results despite an occasional bump because of its tendency to bet on large sectors. The fund has starred at times when drug or tech stocks have outperformed the market. In 1999, its 37.3% total return was about 16 percentage points better than that of the Standard & Poor's 500-stock index. During 1996, the fund's 36.8% return beat the index by 13.8 points. In 1998, by contrast, Buffalo USA eked out a 7.9% total return, nearly 21 percentage points behind the S&P. "A good number of the offerings in the large-cap blend category are closet index funds that just don't deviate much from the sector weightings of the S&P 500," says Morningstar analyst Scott Cooley. "Here you've got active management that is willing to make a few sizable sector bets. That has made for some awesome years when those wagers have panned out, but also some volatility along the way."
Another reason why Laming remains so cool in the face of the tech downturn is because he's used to such things, having parked 40% to 55% of his fund's assets in businesses such as computer networking and semiconductors since its inception in May, 1995. In fact, he's still sanguine about tech, observing that favorites such as Cisco and Intel are suffering mainly from a supply-demand imbalance. It's common to see makers of PCs and other devices boost -- even double -- their orders for components during an up cycle, such as that of the past two years. When the cycle turns down, however, the orders stop, and suppliers get stuck with unsold inventories. That doesn't faze Laming. "We've been adding to positions in some of our larger tech holdings," he says. "Most of the stock fluctuations are due to excess inventories, and during the course of tech booms and busts, you'll see it quite often."
Judged by its name, Buffalo USA Global sounds like a fund that might roam the world looking for holdings. Not so. Laming says he looks to get in on international trade via domestic companies that gather at least 40% of their revenues overseas. That hurdle whittles down his choices to 400 or 500 stocks. Then, the fund filters that group down even further by selecting companies at the center of about 20 key macroeconomic trends that management feels should propel a handful of stocks past their peers.
RIDING THE WIND.
The spread of broadband technologies is, for instance, one trend that stands to benefit holdings such as Cisco and Agilent. The aging of the U.S. population, to name another, explains why Buffalo USA Global has stakes in drugmakers Schering-Plough and Johnson & Johnson. Beyond that, "the reason tech and pharmaceutical companies make our requirement that 40% or more of their revenues come from overseas is simple," says Laming. "They tend to be worldwide leaders, companies that Europe and Asia turn to because, so far, there's little in the way of competition overseas for a Cisco." Similarly, the fund has stocked up on Coca-Cola and McDonald's because each ranks high among the list of U.S. companies whose brands are strong overseas. "All we're looking for is some kind of wind at the company's back," Laming explains. "That might come in the form of better pricing or less competition, but no matter where it comes from, we'll need to see that it's there."
Currently, Laming says he's upbeat about a handful of tech holdings that had a rough go of it in 2000. One example is Agilent, a 1999 Hewlett-Packard spin-off that makes telecom test equipment and semiconductors for products such as cell phones and laser printers. Laming says the company is well-positioned to cash in on several long-term trends. For instance, its optical switching products make it a lock to benefit from the move to bigger bandwidth. Agilent shares, which currently constitute 2.2% of the fund's assets, were hammered in July, when the company warned the Street that third-quarter earnings were lower than expected, and the stock ended the year off 29.2%. Still, Standard & Poor's analyst Megan Graham Hackett thinks the company will log a 20% increase in sales in the fiscal year ending next October.
National Semiconductor is a stock that Buffalo USA Global has held since the beginning, and one that Laming bought recently on weakness. A maker of chips for everything from digital cameras to personal digital assistants and cell phones, National saw its shares come under selling pressure when it preannounced weak second and third quarters. It ended 2000 down 53.0%. Laming says that National, which accounts for 2.4% of the fund, bogged down when cell-phone inventories stacked up and stalled demand for its chips. He adds that the company should get back on track shortly, since cell-phone backlogs will soon melt away. Currently, 12 of the 14 analysts who follow the stock rate it a strong buy or buy, according to Zacks Investment Research. The Street looks for the company's earnings to grow 15.9% over the next five years, Zacks reports.
One tech bet that's just now starting to pan out for Buffalo USA Global is Intevac, a company that makes equipment used in the assembly of disk drives, and which, at 1% of the fund's assets, is one of Laming's smallest stakes. "It's to disk drives what Applied Materials is to the semiconductor business," says Laming. The company was caught in a squeeze in 1999 as disk-storage technology improved faster than advances in semiconductor performance. Because of that, disk-drive makers reduced their orders for equipment.
Laming says the jam is starting to ease, demand for storage is starting to grow, and Intevac shares should make strides this year. Zacks reports that the two analysts on the Street who follow Intevac rate it a hold, although their consensus earnings estimates point to 25% average annual earnings growth over the next five years. After dropping between 30% and 50% a year between 1997 and 1999, Intevac's shares finished down 10.7% in 2000.
Laming's feeling is that while technology shares may be facing a further shakeout in the near term, things should brighten considerably in the second half of 2001. "I think, even though the group is down a lot, we're still going to have problems in technology shares associated with inflated Internet valuations," he notes. "That's going to pressure companies with sound business models like Cisco or Motorola, which probably just need time for excess inventories to whittle down a bit. That may be a few quarters from where we are right now, but I see that as a good opportunity to buy in and wait."
Anderson teaches journalism at the City University of New York. Follow his twice-monthly Sector Scope column, only on BW Online