Although 2000 was a rough year for large-cap growth offerings, the Chesapeake Core Growth Fund (CHCGX ) held up admirably, posting a 6.4% gain -- in contrast to a 9.1% drop in the S&P 500. In 1999, this fund soared 47.6%, while the S&P 500 rose 21.0%, and it now boasts a three-year annualized performance record of 26.2% vs. the S&P 500's 12.3% over the same period.
Co-managed by Whit Gardner and John Lewis, the fund, which is rated 5 Stars by Standard & Poor's, selectively picks stocks from among the largest 1000 domestic companies (based on market capitalization). Fund candidates must have strong earnings growth prospects and can generally resist the impact of macro-economic changes. The portfolio is concentrated among 50 names at all times. The fund is advised by Gardner Lewis Asset Management of Chadds Ford, Pa.
Palash Ghosh of Standard & Poors' FundAdvisor recently had the chance to talk with co-manager Whit Gardner about the fund, its investing strategy, and its top holdings.
Q: How large is the fund currently in terms of net assets? How many stocks are in it?
A:It's about $15.5-million in net assets and comprises 50 stocks -- we always try to keep 50 names in the portfolio.
Q: You are a large-cap growth investor. What specific characteristics must these stocks exhibit to be in your fund?
A:We use a bottom-up investment approach to seek out stocks that we believe can grow their earnings by at least 15% annually -- most of our companies have growth rates far in excess of that. In addition, their stock price doesn't reflect the underlying growth. As such, their valuation will likely expand. We also look for the existence of a catalyst for further growth -- for example, a new product, new management, new distribution strategy, or a new manufacturing technology. Our companies generally have low debt levels and strong balance sheets. We also place great emphasis on meeting and maintaining contact with company management.
In addition, we like companies that are less susceptible to macro-economic changes than most. For example, their results are not highly sensitive to changes in interest rates or energy prices. We control risk and volatility through sector allocation and position size -- we generally will be less than 10% over or underweight relative to the sectors of the S&P 500. And we typically will not invest in companies with a market cap below $5-billion.
Q: What are the top sectors in the fund? Did your technology allocation decrease last year as the market remained weak? What sectors did you add to over the course of the year?
A:Technology currently represents 26.5% of the fund's assets, making it the number one sector. Our exposure to this group declined significantly in 2000, reflecting the market's volatility. We added to health care, energy and financials, as well as capital goods and consumer cyclicals.
Q: You said you avoid stocks that are impacted by macro-economic changes. Isn't this difficult among large-cap stocks, which are multi-national and broadly diversified in nature?
A:Yes, it is impossible to find a large-cap company that is not subject to macro-economic forces on some level. For example, we have some financial services stocks, which can, of course, be deeply impacted by changes in interest rates. But our group includes a company like Citigroup Inc (C ), which can overcome the impact of shifts in rates because of its high, recurring fee-based business and because of the global distribution of its revenue derivation. On the other hand, we won't buy a company like First Union Corp (FTU ), which explicitly says that its profits will be dramatically and directly impacted by changes in interest rates.
Our other top financial picks include Conseco Inc (CNC ), Heller Financial (HF ) and Fifth Third Bancorp (FITB ).
With regard to energy companies -- which, of course, are affected by oil prices -- we focus on drillers, energy service providers, or natural gas firms; that is, we stay away from companies whose fates are directly related to commodity prices. Our top energy companies include Williams Cos (WMB ), Nabors Industries (NBR ) and Weatherford Intl (WFT ).
Q: What are the top five holdings in the fund currently?
A:EMC Corp (EMC ); Boeing Co (BA ); HCA-The Healthcare Company (HCA ); Pfizer, Inc (PFE ) and ALZA Corp (AZA ). EMC and Boeing are the top two names due to their significant price appreciation -- but the third through sixteenth names in the portfolio have virtually the same weighting in the fund; they generally vary by less than 0.2%. As we typically keep 50 stocks in the fund, each represents about a 2% size. Depending on our "comfort level" with a company, we'll correspondingly raise it above 2% or drop it below 2%.
Q: Can you take one of your favorite stocks and discuss how it fits your investment criteria?
A:We consciously made EMC a large position in the fund because we felt that, despite sentiment turning against technology, EMC will not be hurt in 2001 by lower capital spending by corporations on information technology. Data storage is so critical that corporations have to spend money on the services EMC provides. EMC has a wonderful proprietary position -- we've known the management for a very long time, even before they founded the company. Competitors like Sun Microsystems (SUNW ) and Dell Computer Corp (DELL ) do not pose much of a threat to EMC.
Q: Two of your five biggest positions are in drug companies.
A:We have a number of pharmaceutical companies, including Pharmacia Corp (PHA ) and Amgen Inc (AMGN ), because we want to take advantage of two important developments: the patents on several drugs have recently expired, allowing some of the generic drug companies to come into the game and compete. There was also a new resurgence in health-care spending -- a big move toward prescription drug benefits, for example, as well as the country's age demographics. We bought drug companies with a suite of promising drugs that will have a big impact on the market.
Q: Despite a rough fourth quarter, your fund finished 2000 with a 6.4% gain, easily beating the S&P 500 which suffered a decline. To what do you attribute this success?
A:I'd attribute it simply to selective stock-picking within each industry sector -- we concentrate on strong fundamentals and we avoid speculative names.
Q: What are your sell criteria?
A:Our favorite reason to sell a stock is that we can find a better name to substitute an existing holding. That is, as we adhere to a 50-stock portfolio, if we can find a more promising growth prospect for the 50th position, we will. We recently replaced Coastal Corp (CGP ) with Southern Energy (SOE ), a utility company poised to grow through an aggressive acquisition program and which will benefit from deregulation. We still like Coastal, and we actually keep it in one of our other funds.
We'll also sell if a stock reaches our price objective, or when fundamentals deteriorate, or if Wall Street's expectations for a company far exceed ours.
And even though we have an earnings focus, we will not automatically sell a company if they miss an earnings target for a quarter -- we aren't momentum investors; we look at fundamentals. There might be a short-term issue temporarily affecting profits.
Q: What was your view of the market's volatility last year?
A:I think last year's volatility was actually a healthy thing for the overall market -- it cleared out much of the speculative excesses that had infected it. We had an environment in which investors thought that 50%-60% annual gains were normal -- this is just not sustainable. The volatility should eventually settle down, and we will hopefully have companies with stock prices that accurately reflect their fundamentals and earnings growth.