Plucking Opportunity from Panic
Paul Rissman, lead manager of Alliance Growth & Income (CABDX ), looks for stocks that are under pressure, adding them to the portfolio if he thinks the low price is due more to panic than to deteriorating fundamentals. Rissman has recently bought several high-profile companies, including Tyco International (TYC ) and JP Morgan Chase (JPM ), that are suffering from bad news.
Rissman's buying-on-the-cheap approach means the portfolio can be hit especially hard during market downturns. But it can realize healthy long-term gains when depressed picks rebound. In the one-year period through January, Alliance Growth & Income fell 9.9%, while its large-cap value peers lost 8.6%. The five-year period through January shows a brighter picture, with the fund gaining an annualized 12%, compared with 7.7% for its peers. Bill Gerdes of Standard & Poor's FundAdvisor recently spoke with Rissman about the fund's investing strategy, top holdings, and recent portfolio moves. Edited excerpts of their conversation follow:
Q: How would you describe your investment process? A:
Q: How would you describe your investment process?
A:We're relative value managers, not deep value managers. A deep value manager buys a cheap stock with little regard for the company's industry, financial status, or management. Deep value investors are only concerned with a stock's price relative to its intrinsic value.
We buy stocks at a discount to their intrinsic value, but that is a necessary condition, not a sufficient one. We like companies in good industries and run by good managements, but we're relative value managers because we tend to buy stocks at the higher quality end of the cheap stock universe.
Q: How do you find quality stocks? A:
Q: How do you find quality stocks?
A:We start with a universe of about 700 stocks covered by analysts at Alliance Capital and Sanford C. Bernstein & Co. Our team runs these stocks through a selection screen, of which 35% is a dividend-discount model, 35% is a normalized earnings model, and 30% is an earnings estimate-revision model. The first two factors are valuation-based factors, and the third is a growth-based factor, so our screens are about two-thirds value and one-third growth.
Our investable universe is made up of stocks in the top three deciles of our screens, or about 200 names. Looking at the fundamentals, our team then picks about 70 stocks for the portfolio.
Q: Are you a strictly bottom-up investor? A:
Q: Are you a strictly bottom-up investor?
A:We build the portfolio from bottom-up within certain parameters, such as risk-control constraints and tracking error constraints. We try to keep our valuation factors -- price-to-book and forward price-earnings -- in line with the Russell Value Index, and our growth factors and quality factors -- forward earnings growth and historical returns on equity -- above the index.
Q: What are the fund's largest sectors? A:
Q: What are the fund's largest sectors?
A:We're relatively sector neutral because of our tracking error constraints. Financials is a sizable position because it's a large weighting in the Russell Value Index, but we also like the industry's fundamentals. Our biggest financial holdings are J.P. Morgan Chase & Co. and Citigroup Inc. (C ).
Q: What's your view of issues recently raised about JP Morgan? A:
Q: What's your view of issues recently raised about JP Morgan?
A:We generally like to buy stocks when they're under pressure. First, we'll evaluate whether its fundamentals have deteriorated over the long term or the short term. Then, we consider whether the stock sell-off is due to panic. If a fair amount of the low stock price is due to panic, we'll buy more of it. That's why we've been adding to JP Morgan.
Q: You also own Tyco International. A:
Q: You also own Tyco International.
A:Our strategy with Tyco is similar to that for JP Morgan. We reduced our weighting in Tyco when it announced their four-way breakup, but we then bought it back when the stock fell below $30.
Q: Do you still hold Dynegy Inc. (DYN
Q: Do you still hold Dynegy Inc. (DYN )?
A:We also bought it when it was under pressure. We added to it all the way to $17, and it's now back up to $27.
Q: Has Enron (ENRNQ
) had any impact on your performance or process? A:
Q: Has Enron (ENRNQ ) had any impact on your performance or process?
A:Not at all. We bought some Enron at the end of the October when the company was falling apart, and we thought another company would buy some of its assets. The Enron bid from Dynegy was below what we expected, so we sold the stock at a loss, but it had little impact on the portfolio.
Our process hasn't changed because of Enron. I believe Enron is an exception. As people realize that, our portfolio will gain because lot of our holdings are under suspicion. It's very hard to buy cheap companies, since they aren't cheap very often. Now is one of the times to buy cheap companies.
Q: Why did the fund underperform its large-cap value peers for the one-year period through January? A:
Q: Why did the fund underperform its large-cap value peers for the one-year period through January?
A:We did well relative to our peers last year through December, but we've had a rough time over the past two months because the stuff we buy has deteriorated until recently. When the market panics, we normally underperform.
Q: What's behind the fund's good results last year? A:
Q: What's behind the fund's good results last year?
A:We did well earlier in the year largely because of big financial positions, like Bank of America (BAC ) and Household International (HI ). Then, we got hit by September 11, because we were positioned for an economic rebound. After the terrorist attacks, we added to names that were getting creamed, like United Technologies (UTX ) and Juniper Networks (JNPR ). In the fourth quarter, we regained everything we lost in the third quarter and maintained the good performance we had going into the summer.