Mighty Oaks From Smart Stock Picks Grow

The tech-heavy Oaks are flourishing in stormy 2000

Akron could never be mistaken for Silicon Valley. Most of the engineers in this leafy Ohio city make tires--Firestone and Goodyear (GT)--not semiconductors. So what are two of the hottest tech investors in America doing in a place nicknamed the Rubber City? An extraordinary job.

From a small office in Bath, a tranquil Akron suburb studded with oak trees, Jim Oelschlager, 57, and Douglas MacKay, 32, run Oak Associates. The firm's three no-load mutual funds, White Oak Growth Stock (WOGSX), Pin Oak Aggressive Stock (POGSX), and Red Oak Technology Select (ROGSX), have consistently outperformed their peers. In an extremely volatile 2000, White Oak is up 28.2% and Pin Oak 40.9%, while the average U.S. equity fund has risen a meager 4.6% (through Oct. 4). Over the past five years both funds have ranked in the top 5% of their categories, with lower-than-average expenses of just 1%. Meanwhile, two-year-old Red Oak Technology is up 55.5% so far this year, making it the second-best-performing tech fund of 2000. Tech dominates the family. White Oak, a large-cap growth fund, is 60% in tech shares. Pin Oak, which is a midcap growth fund, has an 85% tech weighting. Red Oak, of course, is all tech stocks.

Oelschlager built this extraordinary record from his wheelchair, where he's been confined with multiple sclerosis for the past 18 years. He got his start in money management when Firestone put him in charge of its pension fund in 1969. After the tiremaker liquidated its fund, he set up his own money management shop across town in 1985. Four years later, he hired MacKay as an intern, making him a full-time analyst in 1991. Together they launched White Oak and Pin Oak in 1992. They now have $22.5 billion in institutional assets and $9.5 billion in the funds.

Oelschlager and MacKay demonstrate that you don't have to be in the Valley to understand the Valley. "My Bloomberg machine works as well as everybody else's," Oelschlager quips. Managers too close to the action often suffer from "information overload," MacKay asserts.

CONCENTRATE. What sets Oelschlager's and MacKay's funds apart from rivals is that they're superconcentrated. Each fund owns fewer than 25 companies, compared with 118 in the average domestic equity fund, according to Morningstar. Oelschlager believes most of his peers are "closet" index funds. "If you have too many names in your portfolio, the impact of a great stock is not going to be as meaningful," he says. A smaller portfolio is also easier to track. "They have only 250 to 500 stocks on their radar screen instead of 5,000," says Ed Foster, chief investment strategist at fund tracker Fabian Investment Resources. "That makes it easier to understand each of the holdings in their portfolio."

Oelschlager and MacKay pride themselves on being "big-picture" thinkers. They analyze the economy from the top down to find sectors and industries with the most growth potential--not all that different from other fund managers. But in this way, too, Oak's funds are concentrated: For the past five years, they've been in only three sectors--technology, health care, and financial services. The average domestic equity fund is invested in 10 sectors.

They start their analysis with a few big ideas, which you've heard before: We're in the early stages of another Industrial Revolution, with technology as the prime driver; health care is growing because people, as Oelschlager puts it, "are living longer and taking more pills"; and financial services will benefit from the explosive growth of 401(k)s and buildup in the boomers' wealth.

The crucial step is identifying industries within those sectors that will benefit most. "Getting the industry right is more important than getting the stocks right," Oelschlager says. For instance, in technology, the firm focuses primarily on semiconductors, fiber optics, networking, and data storage. Equally important is knowing what to avoid. The two managers have always steered clear of business-to-consumer Internet stocks, and they recently dumped software.

"RIDICULOUS!" Semiconductor companies account for almost a third of Red Oak's portfolio. Despite a slowdown in personal-computer sales, MacKay is sticking with chips because they're the building blocks of the New Economy. Chips are used in more and more devices--cell phones, Palm Pilots, network routers--not just PCs. "All the intellectual property for these devices is headquartered within the chips," says MacKay. "Cisco may have all the routing software, but the chips are really the guts of the routers." In fact, when Intel tanked in September, the firm saw it as a buying opportunity. "A little revenue disappointment and the stock sells off by 20%--ridiculous!" Oelschlager exclaims.

That doesn't mean the funds own all the same stocks. Oelschlager is lead manager for White Oak and Pin Oak, while MacKay heads Red Oak. At White Oak, Oelschlager usually buys market leaders in each industry--Cisco (CSCO), Intel (INTC), JDS Uniphase (JDSU) in technology, Eli Lilly (LLY) in health care, and Charles Schwab (SCH) in financial services. Pin Oak buys small- to midsize companies in these same sectors (some have grown into large-cap companies, because Pin Oak rarely sells). It owns Digex (DIGX) in technology, Express Scripts (EXRX) in health care, and MBNA (KRB) in financial services.

For Red Oak, MacKay tries to capture the entire growth of an industry by "playing the food chain." For instance, EMC (EMC) dominates data storage, so White Oak and Red Oak own it. "EMC's the core," MacKay says. "They've got a long-term track record and a good management team. Then there's a big push toward attaching storage to networks. Brocade Communications (BRCD) and Network Appliance (NTAP) are emerging as clear winners." Red Oak and Pin Oak own both. And Red Oak owns JNI (JNIC), a component supplier to Network and Brocade.

All three funds own networking leader Cisco Systems, which Oak first bought when it went public in 1990. It has rarely sold a share; adjusted for splits, its cost basis is 7 cents. But networking is changing, MacKay says. "You can't ignore Juniper Networks (JNPR) or Foundry Networks (FDRY) today. They're more successful than Cisco selling to phone companies." Red and Pin Oaks own Juniper and Foundry. But White Oak sticks with Cisco.

MacKay and Oelschlager typically hold positions four to six years. That strategy reduces taxable distributions. When they do sell a stock, it's usually because they've lost faith in the entire industry. Early this year, MacKay dumped most of his PC stocks because he felt PCs have become commodities vulnerable to price wars. He replaced them with Web infrastructure stocks Juniper, Brocade, and Broadcom (BRCM).

A highly concentrated portfolio has its risks: The collapse of one or two stocks can clobber the fund's returns. When Applied Materials (AMAT) and Intel tanked in September, White Oak lost 5% in three days. But holding industry leaders can cushion downturns. Red Oak held up better than most tech funds, for instance, in last April's crash. "We didn't get caught in a lot of second- and third-tier names," MacKay says. "We were down 30%. The Nasdaq was down 40%."

Oelschlager and MacKay aren't about to abandon the tech party. By yearend, Oak plans to launch Black Oak Emerging Technology Fund. That will move the firm further down the food chain, to smaller companies. Sounds riskier, but who'd have thought two guys from Akron would emerge as some of the best tech investors around?

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