The Best Unknown Managers

Here's a peek at how top private investment pros are doing

You could call David Hartzell the Amazing Hartzell. When he was 15, Hartzell, president of Cornell Capital Management, joined the circus and spent two summers away from home juggling, eating fire, and walking the tightrope. In college, he set a world's record: 31 hours lying on a bed of nails. His record as a money manager is also pretty amazing. Cornell Capital's Value Equity Portfolio has delivered a 21% annualized return over the past 10 years, more than doubling the gains of the Standard & Poor's 500-stock index. And that record includes some losses during the bear market, too. (The firm's returns are as of Sept. 30.)

Chances are, you haven't heard of Hartzell, who at age 45 manages $15 million in assets from his home in snowy Clarence Center, N.Y., northeast of Buffalo. He runs only private accounts with a $100,000 minimum investment. These exclusive investments, which are sometimes called separately managed accounts, have become popular because they are more flexible than mutual funds, allowing the money manager to tailor a stock portfolio to suit an individual investor's needs. But their returns are not published in newspapers or magazines, and they're often reported only quarterly. Such info--Hartzell's and others'--is found in databases such as Nelson's Investment Manager Database and CheckFree's M-Search, which brokers use when they sell these accounts to investors.

Now, Morningstar's new Principia Separate Accounts database has opened the door for BusinessWeek to identify hitherto undiscovered managers like Hartzell. The database has its flaws, but it works well enough for us to sift through the 2,200 private accounts to find the top-performing managers. The database, which comes on a CD-ROM, costs $1,395 a year--not cheap, but perhaps worthwhile for investors with large sums who have or are seeking private managers.

Some of the managers in the database, such as Artisan Partners and T. Rowe Price (TROW ), also run mutual funds. But many of the best are virtual unknowns. So if you have separately managed accounts through brokers, you may want to ask about them. What's more, a number of these managers will deal directly with investors, cutting out brokers' fees.

GLOBAL PLAYER. Bill Strong, president of Mason Hill Asset Management, doesn't even work through brokerage firms, but offers his services directly to investors who can meet his $1 million minimum. He charges a flat 1.5% of assets per year as a management fee, unusual in an industry that typically charges 3% for small accounts and as little as 1% for large. His firm has only $60 million under management, but his results and his pedigree are worthy of greater notice.

Strong, 53, cut his teeth during an eight-year stint at the legendary Sequoia Fund (SEQUX ), which is run by two B-school classmates of Warren Buffett's and has long been closed to new investors. He founded New York-based Mason Hill in 1987. A value investor, Strong looks for stocks that are trading at a substantial discount to what he estimates their worth would be as private companies. The discount, he says, provides a "margin of safety" against long-term losses in the portfolio. With his mandate, he can invest anywhere in companies of any size. He has been finding value in recent years in small, obscure companies in Europe and, especially now, in Asia. Oddities such as Kunick, a British manufacturer of arcade games, and Société Immobilière Marseillaise, a French investment company, are the norm for him. With such small companies, he has earned big returns: 20.2% three-year and 22.6% five-year annualized returns, respectively.

While Strong is definitely a bottoms-up stockpicker, Robert Stein, who runs Astor Asset Management's Long-Short Program out of Chicago, is on the opposite side of the spectrum. Stein, 40, started as a project analyst at the Federal Reserve in the 1980s, where he focused on macroeconomic factors that affect the stock market. As a result, he doesn't even trade stocks, but uses exchange-traded funds and index futures to bet for or against the S&P 500.

Stein examines three major economic variables--gross domestic product, employment, and capital expenditures--to determine whether the economy is in an expansion mode or not, then places his bets--long or short--accordingly. "Most money managers invest for one type of economic environment--expansion," he says. "They buy and hold stocks. But the more important thing is to be on the right side of an economic trend."

Stein dislikes being called a "market timer," someone who uses technical indicators such as chart patterns and price momentum to determine whether the market is at a top or a bottom. Rather, he's looking for long-term economic trends. "The main goal of our economy is to create jobs," he says. "If there's more employment, more capital investment, and a higher GDP, then we're in an expansion, and the stock market rises." If the opposite is true, it falls. Last year, the economy lost half a million jobs and the rate of GDP growth declined from 5% in the first quarter to less than 2% in the fourth quarter, so he is still 100% short. Though this negative position has remained fairly constant for the past two years, Stein is not a perpetual bear. He also profited during the 1990s bull market, having a 19.7% 10-year annualized return.

Hartzell's Cornell Capital Value Equity Portfolio is more eclectic than either of these firms. "We don't fit into a specific box," he says. "We buy small stocks, large stocks, growth, and value." Hartzell says he's looking for companies with "great products, great management, and proven earnings every quarter." During the 1990s, he bet heavily on technology, scoring huge gains on AOL (AOL ), Cisco Systems (CSCO ), and Microsoft (MSFT ), but he began shifting some assets toward consumer holdings such as Bed, Bath & Beyond (BBBY ), Dollar General (DG ), Johnson & Johnson (JNJ ), Safeway (SWY ), and Walgreen (WAG ) when the bear market began. He's also a buy-and-hold sort, usually trading only at the end of the year to rebalance the accounts.

HIGHER MINIMUMS. For wealthier individuals--those who can meet the $2.5 million minimum for opening an account--Sterling Johnston Capital Management's Micro Cap Aggressive Growth portfolio could be an attractive option. It has the best five-year annualized return, 29.3%, of any private account tracked by Morningstar. Manager Scott Johnston is a hard-core growth investor, looking for small companies with market caps of less than $1 billion that have accelerating earnings, strong balance sheets, surging stock prices, and a "big catalyst" for future growth.

Johnston, 57, says that in the volatile microcap market, it's important to be a nimble trader. "We get into these stocks very early in their growth cycle, and if a stock goes against us, we get out very quickly," he says. The fund has held upwards of 25% of its portfolio in technology stocks in 2002, yet still has fallen only 8.4% through Sept. 30, thanks to the resilience of Johnston's stocks. He currently has been adding to his shares of Cray (CRAY ), the old supercomputer maker that's getting a new lease on life, thanks to increased sales to the U.S. Defense and Energy Departments.

U.S. FOCUS. Once a money manager gains enough traction running private accounts, he may decide to open a publicly traded mutual fund. That's the case of 36-year-old James Brilliant, who runs Century Management All Cap Value Portfolio. After successfully gathering $830 million in this portfolio and enviable 19.3% three-year and 14.2% 10-year annualized returns, Brilliant is launching the Century Management Fund in February. That fund will still have a steep $100,000 minimum investment, but that's a lot less than the $500,000 currently required for a private account.

Brilliant's style is similar to Bill Strong's of Mason Hill, except that he focuses on U.S. stocks. Brilliant is looking to purchase shares of companies selling at least 50% below their private market value: One of his current holdings is Toys `R' Us (TOY ). The company has been spending heavily on remodeling to update its stores and somewhat old-fashioned image. "Now, their remodeling expenses have already been paid," says Brilliant, "and free cash flow will rise."

Although Brilliant is launching a mutual fund, many of these private managers will always remain private--either because their investment strategies don't work well in a public fund format or because they simply don't want to deal with the hassles of servicing smaller investors. So they will stay relatively unknown, which is to the advantage of anyone lucky enough to discover them.

By Lewis Braham

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