How Walczak Wins at Value Investing

No one would chide fund manager Edwin Walczak if he were insufferably smug these days. In a global bear market, the Vontobel U.S. Value Equity B Fund, which Walczak runs from New York, gained 17.89% for the 12 months ended Oct. 1, compared with a 28% drop in the Standard & Poor's 500-stock index. That made it the top performer of 500 offshore funds in BusinessWeek's annual survey. The fund, which was also the top-rated fund for this year on a risk-weighted basis, boasts a 14.7% average annual return over five years.

But the fast-talking, jocular Walczak, a veteran fund manager, makes light of his short-term achievement. "Everyone goes through these phases," he says. "If you're at the top or at the bottom, things are about to change."

Not that Walczak would ever repudiate the value style of investing that pushed his fund to the top. He buys what he describes as top-flight businesses with long-term earning power at a low price and holds them till they appreciate, a conservative approach that fell rudely out of favor during the tech-stock mania. Smart investing is a long-term affair, and Old Economy companies can also generate strong earnings growth, says Walczak, who has been managing the Vontobel fund since it was created in 1988. "We're value investors," he says. "What does that mean? We want to buy things today for less than they're worth." Unfortunately, he laments, the fickle average investor wants to buy a fund when it's hot, and tends to dump it when it's down. "That's why I'm cynical about managing public money. There are no long-term investors."

Walczak has always been a "value guy," he says, but his investing philosophy has evolved. He is now a disciple of the legendary investor Warren E. Buffett. "We became Buffett Moonies," Walczak says. "We worship the same investment principles that he does."

Walczak worked as a portfolio manager at Lazard Freres in New York from 1984 to 1988 before hiring on at Vontobel, a Swiss private bank. Back then, he followed "a typical wooden approach to value: low price to book value," meaning that his primary criterion for an investment was that its share price be low relative to the worth of its net assets. But over time, he became a convert to Buffett's variant on the value credo, which he says reduces the range of choices to a much more selective group of companies. "Our investable universe is maybe 60 to 100 stocks," he explains, from a range of sectors--companies such as Walt Disney, Hershey Foods, Chubb Group, and American International Group, all of which the fund owns.

HEAVY ON INSURANCE. Those companies and others Walczak buys meet strict criteria: They have straightforward businesses (meaning "How the heck does the company make money, and can I understand it?" he says). They have staying power and make products people want badly or feel they need. Financial criteria include free cash flow, high returns on equity, and shareholder-friendly management. And they must be cheap--either because they're out of fashion or because they've stumbled temporarily. "To use a corny sports metaphor, it's like buying Boris Becker or Tiger Woods in a bad year," Walczak says.

These days, 75% of Walczak's portfolio is in financials, with over 50% in insurance. That sounds counterintuitive in the aftermath of the September 11 attacks, which left major insurance companies with huge liabilities. But Walczak explains that the disaster has changed the business landscape for insurers. Weak players that can't pay claims will shut down, increasing the market share of remaining companies. Plus, he says, companies are already taking advantage of the opportunity to raise premiums. As a result, the sector has outperformed the market since September 11. The Dow Jones U.S. Insurance index is up 6.3% since the debacle, while the S&P 500 is down almost 4% for that period. "We've sold some insurance into strength," he says. "But we're opportunistic buyers since the tragedy."

Walczak's top holding, at 9.7% of his portfolio, is Buffet's Berkshire Hathaway Inc., among whose assets are GEICO and several other insurers. But Walczak wasn't a blind buyer of his idol's stock. "We've owned it less than two years," he says. "We got in at $48,000 [a share] in 2000." That's because during most of the past decade Berkshire Hathaway shares were just too expensive for Walczak's taste. And a value guy has to be true to his creed.

By Julia Lichtblau in New York

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