Akre Adding Cash Joins Stock Pickers Looking Beyond Valuations
Chuck Akre beat 99 percent of peers over more than a decade picking stocks based on price and ignoring much of what happened in the economy and government. He changed his approach after his fund declined 34 percent in 2008.
“It’s not clear how our economic and political situation will unfold so you have to bear more things in mind today,” said Akre, 67, who last year left FBR Funds and started his own Akre Focus Fund. “We need to do a better job of integrating our world view than we have in the past.”
Akre joins a handful of “bottom-up” stock pickers who say they can no longer afford to tune out the larger economic picture after underestimating the financial crisis. Retail investors have pulled $180 billion from U.S. stock mutual funds since 2007, when the crisis started in subprime mortgages before spreading across the global economy and financial markets.
Akre, who returned 12 percent a year as manager of the FBR Focus Fund from 1997 through July 2009, compared with an 8.7 percent annual gain in the Standard & Poor’s Midcap 400 Index, said his concern about the economy prompted him to increase cash holdings in his own fund. He also put money into discount retailers such as Dollar Tree Inc., which can thrive even if U.S. consumers pinch pennies.
Stock pickers are struggling to add value because correlation among assets jumped during the crisis and has stayed above historical averages as investors, worried about another economic slowdown, move in and out of markets without discriminating between individual securities.
“We’re at the highest level of correlation since the 1930s, there’s no dispersion among stock prices,” Lee Ainslie, managing partner at Maverick Capital Management LLC, said last week at the Value Investing Congress in New York. “As you can guess, that makes it very difficult for fundamental stock pickers.”
Since climbing to a record 72 percent on July 16, the correlation between the Russell 3000 and its stocks has remained near that level, data from Birinyi Associates Inc. show. Currently, 95 percent of Russell 3000 stocks have a 50-day correlation coefficient greater than the historical average.
“The world is a riskier place,” said Keith Goddard, president of Tulsa, Oklahoma-based Capital Advisors Inc., which manages $820 million. Historically a stock picker, Goddard, like Akre, said he has moved to a style in recent years that blends stock selection with elements of macroeconomic strategies.
If markets show signs of strain, as evidenced by widening spreads between junk bonds and U.S. Treasuries, Goddard will move money into steady earners such as Purchase, New York-based PepsiCo. Inc, he said in a telephone interview.
David Einhorn, the hedge-fund manager known for shorting Lehman Brothers Holdings Inc. before it collapsed, said in a speech last year that as a “bottom-up” investor he traditionally didn’t see the need to have a view on the stock market or the economy.
“The lesson I have learned is that it isn’t reasonable to be agnostic about the big picture,” said Einhorn, president of Greenlight Capital Inc. Einhorn declined to comment for this article, said Jonathan Gasthalter, a spokesman for the firm.
Fundamental stock pickers select securities by looking at valuations, following the 1934 book “Security Analysis” by Benjamin Graham and David Dodd, the fathers of value investing. Berkshire Hathaway Inc. Chief Executive Officer Warren Buffett studied under Graham at Columbia University. Peter Lynch, who returned 29 percent a year as manager of Fidelity’s Magellan Fund from 1977 to 1990, said it was futile to predict interest rates or the economy.
Most value investors such as Ainslie, David Herro, or Legg Mason Inc.’s Bill Miller say the crisis has created opportunities for stock pickers that will pay off when correlation eventually subsides. Ainslie, whose Maverick Fund has gained about 14 percent annually since inception in March 1995, said he’s looking for companies that are less susceptible to economic swings.
Paying too much attention to economic forecasts can lead investors to buy and sell at the wrong time and miss that opportunity, said Herro, who manages the $5.8 billion Oakmark International Fund and was named Morningstar’s international fund manager of the decade in January. His fund returned 9.4 percent a year over the past decade, better than 97 percent of rivals, according to Morningstar data.
Herro evaluates businesses based on long-term forecasts of their cash flow, and those forecasts aren’t affected much by swings in the economy, he said in a telephone interview from Chicago. While he doesn’t ignore macroeconomic developments, he considers them “not so important,” said Herro, who hasn’t changed his method of valuing stocks since the 1980s.
Akre said while his fund declined less than the S&P 500 Index in 2008, his failure to recognize the seriousness of the housing collapse and its impact on the economy convinced him he needed to pay more attention to economic developments. As a direct result of the financial crisis, Akre said he will hold more cash than he did previously.
“We want to be better prepared for the world we are in today,” he said in the interview from Middleburg, Virginia. The fund had 21 percent of its assets in cash as of July 31, he wrote in an October filing with the Securities and Exchange Commission.
Akre ranked in the top 1 percent of fund managers in his peer group until he left Arlington, Virginia-based FBR last year, according to Morningstar. Akre said he ended the relationship when asked to accept a cut in fees, and opened the Akre Focus Fund. The $233 million pool rose 11 percent this year through Oct. 14, better than 74 percent of peers, Bloomberg data show.
Tucker Hewes, a spokesman for FBR Funds, declined to comment.
At both funds, Akre looked for stocks he calls “compounding machines,” companies that can boost their value by earning high rates of return on capital and reinvesting that money in the business. The companies must pass a third test.
“They have to have managers with equal parts skill and integrity,” Akre said in the interview.
When Akre finds a stock he likes, he holds it for a long time. One of his investments, Markel Corp., an insurer based in Glen Allen, Virginia, has been in his portfolio since 1991. Markel returned 16 percent a year since the end of 1991 compared to 7.6 percent for the Standard & Poor’s 500 Index, Bloomberg data show.
Akre has owned Penn National Gaming Inc., a Wyomissing, Pennsylvania, gambling company since 1996. While the stock gained 17 percent a year over that time, it has declined more than 50 percent since June 2007, Bloomberg data show. Akre sold shares in the company over the past two years, he said, because increased competition in the gaming industry made the investment less attractive.
Robert Rodriguez, who managed the $1.1 billion FPA Capital Fund until taking a sabbatical at the end of last year, says he started his career in the 1970s focusing purely on picking stocks one at a time. Partly because of his experience running a bond fund, he changed his strategy, allowing him to put more than 40 percent of his portfolio into cash ahead of the financial crisis.
“Not paying attention to the macro side could be hazardous to your health,” Rodriguez said in a telephone interview. FPA Capital is the best-performing diversified U.S. mutual fund over the past 25 years, with returns of 15 percent annually, according to Morningstar.
Some of the greatest risks facing investors stem from government policies, said Goddard of Capital Advisors. The large U.S. government budget deficit, $1.29 trillion in the year ended Sept. 30, could trigger an increase in interest rates or a plunge in the value of the dollar if global investors lose confidence in America’s finances, he said.
“I’m not sure you could assign a probability to these events, but the probability isn’t zero,” he said.
Thomas Russo, who helps manage $3 billion at Lancaster, Pennsylvania-based Gardner Russo & Gardner, said the macro trends that interest him as an investor are those that will unfold over many years, not months. He favors companies with business in emerging markets because he expects their currencies to appreciate against the dollar and their economies to grow faster than the American economy.
“The monthly jobs report is noise,” said Russo. “How China and India will do over the next 10 years, that’s not noise.” He said he owns Nestle SA, the world’s largest food company, and not Northfield, Illinois-based rival Kraft Foods Inc., because Nestle has a greater “global reach.”
Akre says he is taking the long-term economic outlook into account when considering which industries look attractive. His fund owns discount retailers Dollar Tree Inc., Framingham, Massachusetts-based TJX Cos. Inc and Pleasanton, California- based Ross Stores Inc.
Shares of Chesapeake, Virginia-based Dollar Tree, Akre’s largest stock holding, gained 56 percent this year. The company sells low-cost merchandise from almost 4000 U.S. stores.
Coping with the federal budget deficit will create hurdles for the economy as politicians raise taxes, Akre said in the interview. For consumers, who are already suffering under too much debt and an unemployment rate near 10 percent, that means less money to spend, he said.
Akre, who has a bachelor’s degree from American University in Washington D.C., says he’s not an economist and won’t try to predict the direction of the market or the economy. His goal, he said, is simple.
“I am trying to figure out how not to give back so much in adverse times.”
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