Big Winner In Big Caps

Stein Roe's David Brady bounces back after Asia

What a launch. Stein Roe & Farnham introduced its Stein Roe Large Company Focus Fund at the end of June, 1998--just in time to catch the worst of the Asian flu, the repercussions of Russia's economic woes, and the near-failure of Long-Term Capital Management. In the third quarter of 1998, the fund lost 13% of its value. "I don't think we could have picked a worse time to start," says David Brady, manager of the $60 million fund.

Brady has redeemed himself in 1999, though. A year ago, when the overall stock market recovered, the young fund started to show its stuff. Its one-year return of 32% is more than respectable (table). Through Sept. 24, the fund has beaten the Standard & Poor's 500-stock index by eight percentage points and is within the top 20% of funds in its category, according to Morningstar.

Success is nothing new for Brady. He is a co-manager of Stein Roe Young Investor, a highly-rated fund with a 25% annual return over the past five years. While many growth funds hold more than 100 stocks, Stein Roe Focus holds just 20 to 25 of Brady's best picks. He looks for companies with proven management that are priced in line with the S&P but have faster earnings growth. Brady's top holding is Microsoft, hardly original but definitely a winner. He likes its consistent, strong earnings growth and new-product cycle, including its recent upgrade of Office 2000 software and the Windows 2000 operating system upgrade that's expected out late this year. Brady believes in playing tech by buying leaders, so he also owns EMC, the leading storage-system maker, and networking giant Cisco Systems.

But Brady is "not just doing whatever works at the moment," says Morningstar analyst Justin Craib-Cox. That would be a sign of weak management and could jeopardize the fund's performance when market conditions change. Indeed, he owns a crop of out-of-favor stocks that he expects to rebound. Novell, which makes software that helps manage large corporate networks, is one example. Investors have spurned the stock because of concerns that sales will suffer after Windows 2000 arrives. But Brady believes that Novell's directory-services product is far superior to Windows 2000's and that corporations will continue to buy it.

Another stock Brady is betting on is Associates First Capital, a consumer lender that trades at only 15 times projected 2000 earnings. The stock has been hurt by rising interest rates, both because the spreads it earns on loans narrow when interest rates go up and because higher rates could slow demand for new loans. But Brady thinks interest rates will retreat from current levels and that the economy will stay strong--encouraging consumers to keep borrowing. He also likes AFS's "terrific management team."

TOY STORY. Brady has been adding stocks from the health-care sector, including drugmakers Warner-Lambert and Becton Dickinson, which have stumbled lately. The fund also holds Mattel despite concerns over the toymaker's weak showing. "The people are outstanding, and the opportunity is very big," he insists. He holds some lesser large-caps as well. While the S&P 500 has a median market capitalization of $68 billion, Large Company Focus' median size is only $27 billion. One reason Brady likes large, but not giant, companies is their potential for takeover. Among them: Avery Dennison, which makes pressure-sensitive labels and other office supplies; SouthTrust, a regional bank that is "an absolute jewel"; and Intuit, known for its Quicken personal-finance software and the popular Web site.

Part of this fund's appeal, like other focused funds, is that "it's a portfolio of stocks investors can get their arms around," says Brady. Investors who approve of what Brady has done at Stein Roe Young Investor and who like his new fund's picks and methodology might want to give it a try.