Online Extra: Allocating for Consistency
Lawrence Babin admits he's not likely to hit a home run in his portfolio. But then again, he's not likely to strike out, either. Babin, who has managed the $2.5 billion Victory Diversified Stock Fund since 1989, has had only a single year of negative returns. That was 2002, when the fund lost 23% -- in line with the S&P 500-stock index.
Under Babin's watch, the fund has averaged gains of 12.63% a year over the past 16 years, outpacing other large-cap blend funds by 2.6 percentage points and the S&P 500 by 1.7 points. Babin recently spoke with Adrienne Carter, a correspondent in BusinessWeek's Chicago bureau, about how he runs the fund. Edited excerpts of their conversation follow:
Q: What's your strategy? A:
Q: What's your strategy?
A:Our goal is to outperform each and every year. We're not going to knock the cover off the ball, but we're also not likely to give up two percentage points of return. In the worst years, we've generally been in the middle of the pack. That enables us to enjoy a pretty consistent, very competitive record of performance.
Q: How do you achieve such consistency? A:
Q: How do you achieve such consistency?
A:We do a combination of both bottom-up fundamental analysis as well as top-down sector and industry viewpoints. And they're equally important. The fund's mandate is to have a representation of each sector of the S&P 500. But we allow flexibility, so we can go as high as twice the weighting in the benchmark and as little as half.
Q: How do you divide the S&P 500? A:
Q: How do you divide the S&P 500?
A:We break the index up into seven sectors: basic industry, capital goods, consumer cyclicals, consumer staples, energy, financials, and technology.
Q: Why maintain some representation of each of those seven sectors? A:
Q: Why maintain some representation of each of those seven sectors?
A:Risk controls -- it keeps us grounded, keeps us humble. We know we're not always right. But being able to underweight or overweight the sectors has allowed us enough flexibility.
Q: Any sectors that you have less than the S&P 500 weighting? A:
Q: Any sectors that you have less than the S&P 500 weighting?
A:Yes, the capital goods and basic industry sectors. We bought those positions during the recession in 2001 and 2002, when those companies were earning well below a normal level of profits. The stocks were reflecting that, and we overweighted the sector. But as business turned for many of these companies recently, we've reduced our positions.
Q: Any areas in which you're overweighted? A:
Q: Any areas in which you're overweighted?
A:The energy sector has been one of the most significant overweights, and even though we've been paring back, it remains so. The demand globally continues to increase, and there are supply challenges that the world is facing [in meeting] that burgeoning demand. We think oil prices are likely to rise, and this should continue for years to come -- $40 a barrel is going to be the floor, and prices could ultimately be more than $100 a barrel within a decade. We have about 17% in energy and utility stocks compared with around 12% for the S&P 500.
Q: What stocks do you own in that area? A:
Q: What stocks do you own in that area?
A:We thought BP (BP ) had a particularly outstanding profile, but we've trimmed that position a little bit because they made a major investment in Russia. It has tremendous potential, but the political situation has turned more devious. To be prudent, we pared back. We also own Transocean (RIG ) and Unocal (UCL ). There has been speculation that Unocal is an acquisition target. It has tremendous reserves.
Q: What makes you decide to sell a stock? A:
Q: What makes you decide to sell a stock?
A:We like to buy value and sell momentum. General Electric (GE ) reflects our discipline. We eliminated GE from our portfolio in the late 1990s. It ultimately sold at $60 and 45 times earning in 2000. But when it became available at a market multiple in the early 2002, we reinstated the position at a modest level. The company had new management. We increased our position as we got more comfortable, had the opportunity to engage the new CEO, and gained confidence in his plans and strategy. By the end of 2002, it was a 5% position.
Q: Are there any value opportunities in the market now? A:
Q: Are there any value opportunities in the market now?
A:The market is at a fairly high level, so you're not finding many stocks that are down in price. We had been really underweight in pharmaceuticals. But the valuation case became apparent to us last year. We've been gradually accumulating some of the stocks, Pfizer (PFE ) in particular. It has remained somewhat controversial. But the valuation case for Pfizer is just about as low as it was when Hillary Clinton was probing the industry.