Moving from Growth to Blend
Matthew Ziehl took over as portfolio manager of the Guardian Park Avenue Small Cap Fund (GPSCX ) on Jan. 1, having come over from Salomon Brothers Asset Management, where he served as "team leader" of their small-cap growth portfolios, including the Salomon Brothers Small Cap Growth Fund (SASMX ).
The Salomon fund dipped 6.6% in 2001, a tough year for the small-cap growth sector, while the Guardian Park Avenue fund declined 7.0%.
Palash Ghosh of Standard & Poor's FundAdvisor recently spoke with Ziehl about the fund's investing strategy, top holdings, and recent portfolio moves. Edited excerpts of their conversation follow:
Q: Are you the sole manager of the Guardian Park Avenue Small Cap Fund or will this fund be team-managed?
A: I am the portfolio manager, but we have a team of research and sector analysts who actually drive the stock-selection process within their respective sectors. However, I am in the hot seat, so to speak, because, ultimately, I am responsible for how the fund performs.
Q: How large is the Guardian fund currently, and how many stocks are in it?
A: It presently has about $175 million in assets comprising 162 stocks. We also run an identical variable annuity product called the Guardian Small Cap Stock Fund which has $265 million in assets.
Q: What will be your buy criteria for this fund?
A: We look for small-cap stocks. We define small cap as those which are smaller in cap size than the 600 largest U.S. companies. At the moment, that cut-off level is roughly $2.8 billion.
Typically, new stocks in the portfolio will range in size from $250 million to $2 billion. While we are committed to keeping this a small-cap fund, we will be flexible enough not to dispose any individual stocks just because they appreciate quickly and their market cap grows beyond the small-cap range.
We look for high-quality companies based on a bottom-up, fundamental research strategy. We place high emphasis on such parameters as consistency of earnings, quality of earnings, the ratio between cash flow and earnings, and solid balance sheets (as opposed to balance sheets which are puffed up with goodwill or bloated with debt). We also want companies with a very strong management, clear strategy and a strong business model.
Q: How, if at all, will you change the way the Guardian fund is run relative to the way the prior managers ran it? Have you already started making changes to the portfolio?
A: We are adopting more of a "core blended" approach -- that is, we will invest in both value and growth stocks, whereas this was more of a growth fund before.
We are also in the process of reducing the number of names in the portfolio because I want to focus on our best ideas. We would like to get the portfolio down to about 100 stocks -- when I got here the portfolio had over 200 names. For example, we might (currently) have two stocks in the same industry -- we'll dispose of one, and keep the one that is the incrementally better idea.
When I arrived here, the portfolio was very well diversified across sectors -- and I want to maintain that diversification -- but I also want to narrow the focus on a stock-specific basis. We want to be more willing to place larger positions on stocks in which we have the greatest confidence.
Q: How will you manage sector allocations?
A: We want to keep our sector weights quite close to the allocations of our benchmark, the Russell 2000 Index, except for stocks in which we have very high degree of conviction as a result of our bottom-up strategy. For example, we are currently a bit overweight in energy stocks, relative to the index -- not because we have a top-down bullish view on the energy sector, but rather because we have found certain energy stocks in which we have strong conviction, such as Patterson-UTI Energy (PTEN ).
Q: Can you name a stock that you had in both funds?
A: We held Commerce Bancorp (CBH ), a New Jersey-based regional bank, in the Salomon fund, and it was already in the Guardian fund before I came here. I've increased our exposure to it. Commerce is an excellent consumer bank. Unlike many banks that are pushing automation over customer service, Commerce is actually growing branches, including an early expansion into Manhattan. They are taking retail customers away from larger banks that are cutting services.
Commerce's business is being driven largely by exceptional deposit growth (something like 15% per year). They have a very solid credit profile as well as a low loans-to-deposit ratio. Their asset portfolio is mostly in low credit-risk government securities. They are in a terrific position to grow their business, despite the current environment of weakening consumer credit. Since late September, 2001, this stock has jumped from the low-$30s to the low $40s.
Q: Can you discuss a stock that you carried over from the old fund into the new fund?
A: Cost Plus (CPWM ) is a specialty retailer that started in California in the late 1950's and went public in 1996. They're a growing chain. They sell housewares, furniture, food, and beverages -- like a hybrid of Pier 1 and Trader Joe's. The stock has suffered some bumps in recent quarters due to the weakening economy and some inventory management issues, but they are overcoming these short-term problems.
Although the retail environment during Christmas was mixed, Cost Plus came through at the upper end of their sales expectations. Cost Plus's stock price was as low as $15 in late September. It has since rebounded to the $25 level.
Q: What is your outlook for small-cap stocks this year?
A: Since the tech/Internet bubble burst in early 2000, small-cap stocks have outperformed large-caps. However, an even more dramatic divergence has occurred between styles -- value equities have trounced growth stocks, particularly within the small-cap sector.
Now, since the market lows of Sept. 21, 2001, growth appears to have made a bit of a comeback. I have to believe the style volatility has to calm down somewhat. However, we don't want to be excessively exposed to any style bias -- that's why we are running a blended portfolio.
Q: What is your outlook on the small-cap tech sector?
A: Tech stocks have led the rebound since late September, 2001. Tech is the most high-octane portion of the small-cap universe, along with biotech and genomics.
Our sector-weighting in tech is neutral with respect to our benchmark -- we're somewhat defensive within our tech holdings. Specifically, we're overweight in software and services, while underweight in telecom equipment, computer hardware, and the Internet. Overall, we are a bit cautious on tech -- we think the dramatic rebound in tech since the late-September lows has outpaced any improvement in fundamentals in the sector, so we think it's been quite overdone and premature.
From S&P FundAdvisor