While the telecom sector currently hangs over the market, John Schneider, manager of PIMCO Value Fund/A (PDLAX), thinks an industry shakeout is paving the way for an upturn in the sector. This contrarian thinking reveals his penchant for turnaround situations. Schneider looks for catalysts, such as supply/demand imbalances, new management, or cost cutting initiatives, to get things moving.
Schneider's move into telecom is a shift from last year, when he focused on defensive sectors, such as health care, utilities, and property and casualty insurance. That game plan paid off. For the one-year period through July, the fund surged 39.3%, versus a decline of 14.3% for the S&P 500. (The fund carries an S&P three-year overall rank of 4 stars, meaning it has displayed a superior combination of risk and return.) Schneider, who took over the fund last May, says he changed the fund from a mid-cap product to a large-cap portfolio "made of cheap stocks."
What does Schneider like in telecom now? His current top picks include WorldCom Inc. (WCOM ) and Sprint Corp. (FON ). Outside of telecom, Schneider believes aluminum producer Alcan Inc. (AL ) will benefit from the California power crisis. And in a foray into energy, he recently purchased Transocean Sedco Forex (RIG ), an offshore drilling outfit.
Bill Gerdes of Standard & Poor's FundAdvisor recently spoke with Schneider about the fund's investing strategy, its top holdings, and recent portfolio moves. Edited excerpts from their conversation follow:
Q: What do you look for when selecting stocks?
A:Every stock we buy has a catalyst, which could be a supply/demand imbalance, new management, or a cost cutting initiative. We run a relatively concentrated portfolio of 40 to 45 names, primarily chosen from the bottom up.
Q: The fund's turnover is relatively high at about 196%. Do you trade frequently?
A:This is because I completely redid the portfolio when I took over. Turnover is now about 80% annually. I am pretty patient as an investor. I will buy more of a stock as long as the catalyst is in place.
Q: Can you describe a holding that has a catalyst?
A:The catalyst for Alcan was an aluminum shortage, caused by the California energy crisis. As a result of power shortages, aluminum smelters there shut down, cutting 8% of the world's aluminum production.
Q: What other investment trends are you following?
A:I don't take a top-down approach. Last year, however, we were defensive, focusing on health care, utilities, property and casualty insurance, and some staple areas, like tobacco. This year, we still like property and casualty insurance, but we've moved into cyclical companies, such as Alcan and truck maker PACCAR Inc. (PCAR ). We've also gone from a zero weighting in telecoms to a 12% stake.
Q: Many investors have given up on telecoms. What do you see?
A:We are just at the cusp of a turnaround in telecom. Telecom overspending led to lower prices and many little guys going bankrupt. This will be a classic case of spending cutbacks leading the sector to correct as excess supply eases.
One telecom holding, WorldCom, is down dramatically compared to when it was a growth stock. Sprint, another attractive company, has hidden assets in its large local phone business. If you take its stock price, and reasonably value its local phone service, you are getting the long distance operations for free.
Q: What is your view of the technology sector?
A:I don't run from technology like many value managers. I owned a fair amount of tech in 1999 and nothing last year. I'm starting to nibble at tech, but not a lot. It is about 5% of the fund. I only hold what I call commodity technology plays, not evolving technologies. One commodity technology holding is Micron Technology (MU ), a producer of DRAMs. DRAM supply should fall as high-cost producers in Korea and Germany cut capacity.
Q: Why has the fund performed well this year and last year?
A:Last year, when we were going into a recession or were afraid of having one, I was pretty defensive, owning health care, energy stocks, property and casualty insurance, and staples, such as Philip Morris (MO ). This year, the fund has done better because I pared back in those areas, except for property and casualty insurance. J.C. Penney (JCP ) has been one of our best performers this year.
Q: Why has property and casualty insurance done well?
A:After a decade of no price increases, a number of insurers went bankrupt, so the better players could raise prices by double digits. Two holdings, both 5% positions, ACE Limited (ACE ) and Aon Corp. (AOC ), have gained from big price increases.
Q: What are the fund's largest holdings?
A:They include Alcan, ACE Limited, Sprint, WorldCom, Micron Technology, and CIGNA Corp. (CI ). With the cost of health-care going up, CIGNA will gain from medical inflation.
Q: What have you purchased recently?
A:I've been buying some energy stocks, which have gotten killed in recent months. Last month, I bought Transocean Sedco Forex. The stock price doesn't reflect the value of its huge offshore rigs, each worth millions of dollars. Offshore drilling is the cheapest way to drill for oil, costing as little as $10 a barrel.
From Standard & Poor's FundAdvisor