The Secret to This Fund’s Stellar Record: Don’t Lose on Way Down

  • Eaton Vance’s $7 billion fund tops 99% of peers over decade
  • ‘The key to making money is not losing it,’ manager says

Matthew Hereford’s mutual fund keeps pace with the stock market in good times and beats it during bad spells. That’s put his fund on top.

The $7.1 billion Eaton Vance Atlanta Capital Smid-Cap Fund beat 99 percent of peers over five and 10 years, and had the best risk-adjusted returns over both periods, according to data compiled by Bloomberg. Its best years compared to rivals were in 2008, when the S&P 500 Index plunged 37 percent, and 2011 and 2015 when the measure was little changed.

Hereford and his co-managers win by favoring what he calls “simple boring businesses” with strong, predictable cash flows. The companies they invest in, such as insurers, can be resistant to economic cycles. They thrive with the economy during recoveries and hold up when growth slows or ceases.

“The key to making money is not losing it,” Hereford said in a telephone interview. “If we can preserve what we have in more difficult environments, there will be that much more principal to grow on the way up.”

Active vs. Passive

The Eaton Vance fund, which focuses on stocks with values of at least $3 billion, is doing well even as investors are leaving stock pickers’ funds amid lackluster returns.

Slightly less than 35 percent of actively-managed equity funds beat their benchmarks in the first four months of this year. In 2015, 47 percent did, compared with 26 percent the year earlier, according to data compiled by Morningstar. Investors responded by pulling about $193 billion from funds run by stock pickers over the past 12 months and added money to funds that track indexes.

Hereford’s fund gained an average of 13 percent a over the past five years compared with 9.5 percent for its benchmark, the Russell 2500, which tracks small and mid-caps. Over 10 years, it beat the benchmark by an even larger margin. The fund’s top risk-adjusted returns, a measure of performance per unit of risk, reflect both robust absolute gains and lower than the average volatility, according to data compiled by Bloomberg.

Eaton Vance’s Top Four Stocks

CompanyBusiness % of Fund
Markel Corp.Insurance4.43
Ansys Inc.Business software3.70
Sally Beauty Holdings Inc.Beauty products3.53
Dentsply Sirona Inc.Dental supplies3.47

The managers follow an investing style long associated with Warren Buffett: they buy strong businesses and hold on to them. (The average market cap of Eaton Vance’s holdings is just under $7 billion.) The biggest position in the fund, insurer Markel Corp., has been the largest holding for most of the past decade, said Hereford.

Markel writes insurance for niche markets including summer camps and horse stables. Since few insurers focus on such customers, Markel is able to avoid the price wars that ensue when competitors vie for the same business.

Markel gained 11 percent a year over the past decade compared with about 7 percent for the Russell 2500 Index. The Glen Allen, Virginia-based company has increased net income an average of 17 percent in the past five years, according to data compiled by Bloomberg.

‘Old Economy’ Companies

When top holdings leave the portfolio, it’s often beyond the managers’ control. In October, HCC Insurance Holdings Inc., which had been in the fund since 2007, was acquired by Tokio Marine Holdings Inc. for $7.5 billion, 38 percent more than the stock’s closing price before the deal was announced. HCC provides insurance to the aviation and energy industries, among others.

“The price was nice, but I would rather have owned the company for the next 10 years,” said Hereford. “I think we would have made even more money.”

Like Buffett, Eaton Vance’s managers mostly stick to old economy companies that are easy to understand. Aside from insurers, they’ve invested in construction material suppliers and companies that distribute dental supplies. The portfolio doesn’t include biotech stocks, a staple of many small and mid-cap funds.

“A lot of investors gravitate to complexity,” said Hereford. “We shun it. ”

Hereford, 43, and William Bell, 43, have been co-managers of the fund since 2004. The other manager, Charles Reed, 50, started in 2002. Before joining Atlanta Capital, Bell and Reed managed the pension fund for Florida state employees. Atlanta Capital, a majority-owned subsidiary of Boston-based Eaton Vance Corp., oversees about $18 billion.

Besides free cash flow, the managers look for companies that use cash wisely. They will dump a stock that engages in what Hereford calls “boneheaded acquisitions.” The fund sold its stake in Jacobs Engineering Group Inc. in the first quarter of 2015 after the firm bought two companies at the peak of the mining cycle for a combined $1.9 billion. Jacobs has gained 11 percent since March 31, 2015. The Russell 2500 lost 4.9 percent over the same stretch.

In contrast, Fair Isaac Corp., known for the FICO credit score, earns loyalty from Eaton Vance because the company has steadily bought back shares over the past 10 years at prices well below today’s levels. Fair Isaac has been in the fund for more than 10 years and has climbed 12 percent annually over the past decade, compared with about 7 percent for the Russell 2500.

The fund lost money on merger advisory firm Greenhill & Co., which it held from 2009 to 2011. Greenhill fell 58 percent, included reinvested dividends, from the end of the second quarter of 2009 to the end of the third quarter of 2011, according to data compiled by Bloomberg, as key executives left.

“It turned out the assets -- the people -- were too portable and they walked out the door,” said Hereford. “We missed that so we sold.”

Eaton Vance also sticks with companies they have faith in. Affiliated Managers Group Inc., an asset manager that acquires other money managers, fell 24 percent over the past year, hurt by a volatile stock market. Eaton Vance boosted its stake in the company in the first quarter by about 40 percent, regulatory filings show. The fund has held the stock for more than a decade.

“We bought it near the bottom,” said Hereford. “We thought it was a case of the baby being thrown out with the bathwater.”

Michael Mullaney, who helps oversee $11 billion as chief investment officer of Fiduciary Trust Co. in Boston, said many managers strive to follow Eaton Vance’s strategy of buying high quality stocks that hold up in downturns and perform respectably on the way up.

“If you do that over time you will annihilate the benchmark,” he said in a telephone interview. “The problem is, it’s very hard to do.”

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