Peter Trapp's Bear Repellant

For Needham Growth's fund manager, flexibility and shrewd picks have helped him stave off the worst of the carnage

By James A. Anderson

Even with all the market uncertainty and volatility, most mutual-fund managers can agree on one thing these days: Whenever you see a bear as big and vicious as the beast that has clawed at Wall Street lately, there's probably nowhere to hide. Still, it sure doesn't hurt to have a few deft moves to help you avoid being mauled.

Peter Trapp, who picks stocks for Needham Growth (NEEGX ), has been busy with some fancy maneuvering since early 2000 -- all in the name of keeping the damage to a minimum. When technology stocks steered off-course in 2000, for instance, he began shorting a number of names in the group. When corporate profit projections drifted south earlier this year, he shifted a chunk of his portfolio assets to short-term Treasuries and even some agency paper.

"It's all a matter of having alternatives," says Trapp. "Most fund managers are forced by their charters to keep fully invested in stocks, even when the market is down. We're lucky to have more flexibility, and that's something you'll see us use in markets like this one."


  The fund has exploited that leeway to good advantage. The numbers show that Needham Growth has dodged a horde of problems in the tech sector and the market in general, gremlins that have sidetracked a good many of its peers since mid-year 2000. That's thanks in part to its short sales but to a greater extent to the chief's stock-picking skills.

In fact, the Needham fund has surpassed its mid-cap growth peer group so far in 2001 with a year-to-date total return of -2.5 -- nearly 16 percentage points better than the Standard & Poor's 500-stock index, which actually places the fund in the top 1% of its peer group. A three-year average annual return of 34.3% is practically 31 points beyond the S&P 500 and again puts it in the top 1% of its group. Looking over five years, the fund's 20.9% is 10.5 points higher than the market benchmark and good enough to place it in the top 3% of its group.

Trapp describes himself as a "growth at a reasonable price" manager and says he aims to snatch up shares of companies that have fallen out of favor. He looks for candidates that are selling at a price-to-earnings multiple of 50% below their projected profit growth rate, preferably as long as they can boost earnings at a 15% to 20% annual clip.


  Once Trapp stakes a position, he plans to stay put until it rises to a p-e roughly equal to its growth rate. That, he says, is the moment of reckoning. He'll then review the company, its business, and prospects. If Trapp decides his position is fully valued, he'll fold his hand and collect his gains. He generally looks to hang onto selections for 12 to 18 months.

If he's more optimistic, however, Trapp says he'll opt to put a collar on the shares, a hedging strategy that uses options contracts to limit downside risk. If things go his way, he'll sell out when a company's multiple is about 1.5 times its growth rate. "I'm not a momentum player -- I'd rather leave money on the table than get hit with a downturn," he explains.

Trapp likes to tap the research strengths of the fund's parent investment bank, Needham & Co., which tends to focus its energies on sectors such as technology, health care, and specialty retailers. Indeed, as of June 30, the fund had some 57% of its assets in tech and telecommunications holdings, while health-care and pharmaceutical companies made up 11.9%. Among Needham Growth's largest positions were tech companies such as Coherent (COHR ), Compaq (CPQ ), and Motorola (MOT ).


  Then again, Trapp says he also has something of a penchant for mid-, small-, and micro-cap stocks. Because those same companies might not be widely covered by brokerage houses, Trapp feels he can get an edge on the market. Take Kronos (KRON ), a business-software maker that's followed by only four analysts, according to Zacks Investment Research. The stock has soared 67.1% year-to-date as of Oct. 5. Another relatively obscure holding is Conmed (CNMD ), a maker of arthroscopic implants. The stock, which is tracked by only seven firms, has posted a 56.7% gain in 2001 as of Oct. 5.

These small-fry picks are one reason the fund's median market cap is $738 million, compared to a $4.2 billion median for the average mid-cap growth fund, according to Morningstar. But Trapp also holds a handful of big names, such as AT&T (T ) and Corning (GLW ), companies he says fit his pricing and value criteria.

Trapp is still maintaining a sizeable short position -- currently about 20% of his assets -- although that number is down from the summer high of 25%. Over the year, however, he says he has started to shift away from shorting tech as heavily as he did in 2000. "The group is down, and it's going to be harder to make money on the short side, apart from some companies in the software area or a few specialty chipmakers," he says. "We've harvested much of the low-lying fruit in that sector, and we've moved on to industries where we find more egregious overvaluation."


  The fund manager won't divulge individual companies he's betting against, but he counts among his list of overvalued industries subprime lenders, auto-parts makers, advertising firms, homebuilders, and lodging and gaming companies. "Consumer spending has fallen off a cliff," notes Trapp. "Confidence is plunging, so companies that depend on discretionary, high-end spending are likely to struggle in this environment."

Needham Growth's wagers against the market could prove to be a good cushion in the next couple of months, especially in view of the start of U.S. military action in Afghanistan. "The management has certainly done a good job picking its positions," says Morningstar analyst Russel Kinnel. "And in this market, it should help the fund do better than the competition, although it could hold back results in a big rally."

One holding that has Trapp enthusiastic is AT&T. "This is a stock that has the kind of characteristics to do well in a defensive market," he says. Besides that, Trapp thinks AT&T's split-up is worth a play. "I look at the company, and adding up broadband, business services, and wireless, it totals $39.50. Factor in other assets and debt, you get about $27 a share in value." With that kind of upside, Trapp reasons, AT&T is attractive, particularly at its close of $18.87 a share on Oct. 5.


  He also likes Motorola (MOT ). Trapp says the stock was sunk earlier this year on concerns that wireless-infrastructure upgrades were delayed and predictions that cell-phone volumes would head downward in 2001. Trapp says Motorola, however, is starting to win back some of the market share in cell-phone handsets that it lost to Nokia (NOK ). He thinks Motorola, which closed at $16.90 a share Oct. 5, could climb its way back to $25 in a year.

If there has been a knock on Needham Growth in the past, it was the fund's lofty expense ratio -- some 2.2% of assets, compared to 1.5% for the average mid-cap growth fund, according to Morningstar records dating from last year. Since then, that figure has come down to 1.8%, thanks in part to the fund's track record. Trapp says the explanation is simple: Needham Growth has kept costs in check, while bringing in some $200 million in new assets above the $76.1 million it had in the coffers as of Jan. 1, all a product of its fine track record.

Cutting down on airfare, however, wasn't part of Trapp's original plans to tighten his fund's belt. Generally, he likes to get out at least one week each month to snoop around some of the companies he owns and talk shop with management. For the time being, though, Trapp says he's cutting down on business travel: "Right now, I'm sticking closer to home to protect our gains. I've been in the business since 1973, and frankly, even compared to the '73 to '75 market, this has got to be the toughest I've been involved in." But too tough for Trapp? Don't count on it.

Anderson teaches journalism at the City University of New York. Follow his Mutual Fund Maven column, only on BW Online

Edited by Patricia O'Connell

Before it's here, it's on the Bloomberg Terminal.