Online Extra: This Fund's Flexibility Pays Off

The go-anywhere Leuthold Core Fund prospers through its ability to invest in any kind of stock, bond, commodity, or future

If you want an honest investing tip, talk to a money manager who can invest anywhere. As co-manager of the $1 billion Leuthold Core Fund, Eric Bjorgen has the flexibility to put money into stocks and bonds of any stripe as well as more exotics assets such as commodities or futures.

Such investing latitude has helped Bjorgen deliver a 10% annualized return to shareholders over the past five years, which surpasses both the average stock fund's and the average bond fund's returns by a wide margin.

But more important, he has no axes to grind, no chosen sector to promote. Lewis Braham, a personal finance writer for BusinessWeek, caught up with Bjorgen in his Minneapolis office. Edited excerpts of their phone conversation follow:

What trends have you seen this quarter within the different asset classes? Are there any inflection points?

Within the equities market, there's definitely a transition from a small-cap-dominated market to one that's less small-cap-dominated. As for an inflection point, I might say the market is large-cap-dominated, but that's an example of where we're starting to see perhaps a change -- but not a reversal of trend.

So here we've seen small caps outperform for going on four years now, and we don't suspect that's going to continue. In looking at a number of different variables, our assessment is that small-cap leadership is over, and we might turn to a parity relationship before we reach a point where large caps outperform.

Where are you finding the best opportunities right now?

Within our equity portfolio, our quantitative work is putting us in a couple of directions. The first is health care. We have a pretty heavy health-care exposure right now, 28% of the equity side of the portfolio.

We've got a position in big pharmaceutical companies that's almost 10% and another 13% in a conceptual group we call health-care cost-containment -- companies offering products or services that help control costs. We think it's a group that will have a good fundamental story for the long term.

Can you give me an example?

Cerner (CERN ) -- they make software for health-care systems that controls all aspects of ordering and inventory control. It's meant to increase the efficiencies of clinics and hospitals.

What about biotech, which has been rallying lately?

We haven't invested there yet, but it's a group we're finding attractive in our work. I would say it makes sense as a long-term investment.

We own [makers of] both generic and the branded drugs as a hedge against the legal risks. You've got generic companies suing branded drug companies and branded drug companies suing generic companies over patent expiration.

With biotech, the play goes beyond the standard small-molecule drugs and goes into a realm of drugs largely undeveloped yet. Most of the companies are still in the earlier marketing or developmental stages aside from Amgen (AMGN ) and Genentech (DNA ) and companies like that. But it's a very promising growth industry, and there certainly seem to be some good health-care cost-containment plays there as well.

If you can take a therapeutic biotechnology product and thereby avoid expensive surgeries or enable a patient to stay at home on a therapeutic course rather than have an extended hospital stay, it's better for the long term as far as health-care costs go. So biotech does fit within our cost-containment strategy.

What are the quantitative factors that are attractive in health care?

I can't give you a broad characterization. There's no way a group can be this big a weighting in our portfolio on the basis of just one or two strengths. It's a weight-of-the evidence approach. You have to have a number of factors that are strong to propel a sector to the top of our quantitative rankings.

What are your thoughts on other asset classes?

Certainly, the earnings growth looks good in emerging markets. We still have a 6.5% weighting in this area, above our normal target of 5%.

Yet we've had concerns of late that the markets in Latin America, Asia, and Eastern Europe have gotten too frothy. Whenever you begin to see a lot of retail money being thrown at a specific asset class, regardless of whether it's bonds or stocks or whatever, you have to get concerned about that.

Moreover, the markets have become more correlated with the U.S. The old adage that as the U.S. economy goes, so goes the rest of the world is probably true for emerging markets as well.

We also have a 6% weighting in hard assets. We implemented that in January, 2004, and saw this as a long-term holding. [The fund's founder] Steve Leuthold described this bet as a three-act play. Where we are right now is in the middle of the second act.

The overriding rationale is that we really have identified a long-term supply-demand imbalance that would take a long time to correct, because the demand for metals has come on so fast due to the emergence of Pacific Rim economies. The mining operations take several years to come up to speed as far as increasing production, and they got blindsided by the rise in demand.

What about oil and other commodities?

Oil we're cautious on. It's difficult to imagine a long-term support for oil prices right now. In fact, we've been looking for an oil correction for some time. Sooner or later there will be a reaction to the high prices, either a slowdown in the global economy or a reaction on the part of oil consumers to pull back the reigns of oil consumption.

Yet the timing of a pullback is difficult to predict. You've got the influence of OPEC and their actions as well as the supply constraints. Now the supplies are so tight that any one single country or region can affect the global output and put a dent in it.

What about bonds?

This has been the area where it has been most difficult to find opportunities. In May we initiated a position in corporate bonds in the automotive sector after their credit ratings were downgraded. Other than that, the opportunities are very slim.

If you just look at a historical interest rate chart, you can see that interest rates tend to trend in a secular fashion. That doesn't mean we'll see rates back up where they were in the 1980s, but to believe that rates will stay this low over the intermediate to long term is just ridiculous.

That said, you have to wonder where the opportunities in fixed income will come from. We sometimes get income from unconventional means such as real estate investment trusts (REITs) or high-yielding utilities. Just in terms of overall bond exposure, it's very difficult. We've got a 9% fixed-income hedge in place right now.

Are you saying the biggest opportunity in fixed income right now is to short bonds?

Not exactly. This is a tactical strategy -- rooted more in the spirit of a hedge -- to protect the portfolio against a rise in interest rates rather than a strategy to make money shorting bonds.

Of course, it's nice if our shorting the 10-year Treasury bond works out and we profit from it, but to characterize it as a short bet belies the spirit of what we're trying to do -- which is to hedge against what we expect to be an environment of rising rates.

Edited by Patricia O'Connell

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