Touchstone Wins on Will to Walk Away: Riskless ReturnCharles Stein
Frank Sands Jr. isn’t afraid to hold fast-growing but volatile stocks such as Starbucks Corp. and Amazon.com Inc., or sell a big winner, like Apple Inc., when he thinks it’s past its prime.
That discipline propelled the $3.5 billion Touchstone Sands Capital Institutional Growth Fund to the best risk-adjusted performance over the past five years among 72 U.S. growth funds that buy shares of large companies, according to the BLOOMBERG RISKLESS RETURN RANKING. The fund produced returns, after adjusting for price swings, of 5.1 percent in the five years ended Sept. 30, beating similar offerings from T. Rowe Price Group Inc. and Fidelity Investments.
Picks including Starbucks, which more than quintupled over the past five years, and Amazon.com, which more than quadrupled, helped the fund generate the best absolute returns in the group, helping to mute the impact of high volatility. Sands Jr. holds on to his stocks as long as they satisfy the criteria he has laid down for growth companies, including above-average earnings growth and “game-changing” businesses with competitive advantages, according to fund documents. When a business no longer meets his targets, he sells it, as he did earlier this year with longtime holding Apple.
“The problem with growth investors is that they fall in love with sexy and exciting stories and wind up selling too late,” said Michael Rosen, chief investment officer of Santa Monica, California-based Angeles Investment Advisors LLC. “These guys stick to their discipline,” said Rosen, who invests institutional money with Sands Capital Management, the manager of the Touchstone fund.
Sands Jr. declined to be interviewed for this story.
Apple, based in Cupertino, California, rose more than fivefold between Sept. 30, 2006, when it first appeared in the fund’s portfolio, and June 30, according to data compiled by Bloomberg. The fund sold that stake in second quarter, as the market for smartphones is becoming saturated in developed countries and sales in emerging markets will be less profitable, according to a letter to shareholders.
“Even great companies mature,” the firm wrote, explaining the decision to sell Apple.
Sometimes, the fund exits a position too early. Sands Jr. sold Netflix Inc. in the third quarter of 2012 after losing confidence in the way the Los Gatos, California, online movie rental company was being run and finding fault with several “poorly executed” actions by management, according to a letter to shareholders in the fund’s 2012 annual report. Netflix has more than quintupled since Sept. 30, 2012.
“These managers know they are going to make mistakes,” Michelle Canavan Ward, an analyst with Chicago-based Morningstar Inc., said in a telephone interview.
The risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit of risk. The returns aren’t annualized.
Touchstone Sands Institutional Growth Fund’s top risk-adjusted performance combined the best cumulative return, 145 percent, over the past five years with volatility of 28.4, higher than all but two of the large-cap growth funds.
Sands Capital, on its website, said that higher volatility may result from running a concentrated portfolio. The growth fund has 30 stocks, and its top 10 holdings represent 54 percent of assets. The firm makes the case that over time concentration has contributed to better results.
The $2.4 billion Nicholas Fund ranked second with risk-adjusted performance of 4.1 percent, combining the fifth-highest return with below average volatility.
The Touchstone fund also beat the $51.4 billion Fidelity Growth Company Fund, which ranked tenth on a risk-adjusted basis, and the $7.9 billion T. Rowe Price Institutional Large-Cap Growth Fund, which ranked fifth.
Touchstone Investments, based in Cincinnati, manages $15 billion. The firm sells funds managed by more than 20 sub-advisers, including Arlington, Virginia-based Sands Capital.
Frank Sands Sr. founded Sands Capital in 1992. His son, who joined the firm in 2000, succeeded him as chief executive officer in 2008. Sands Jr. has a bachelor’s degree from Washington & Lee University in Lexington, Virginia, and master’s degrees from Johns Hopkins University in Baltimore, and the University of Virginia in Charlottesville, Virginia.
The firm looks for businesses that are creating new markets, according to the 2011 annual report of the Touchstone fund. Those businesses have to meet six criteria, including sustainable earnings growth that outstrips those of peers, competitive advantages and financial strength. Sands seeks to buy them at “rational valuations.”
The portfolio has a price-to-earnings ratio of 39, compared with 21 for the benchmark Russell 1000 Growth Index, according to portfolio data compiled by Bloomberg. Compared with the benchmark, the fund has a greater weighting in consumer discretionary stocks, health care, information technology and energy. It holds no financial or industrial shares, according to data compiled by Bloomberg.
Sands Capital discovers companies through its own research, according to Angeles Investment’s Rosen.
“Every firm will tell you they do a tremendous amount of research on companies, but they really do,” said Rosen, whose firm helps investors overseeing $40 billion in assets.
To gauge the appeal of Nike Inc. sneakers and apparel, the Sands Capital team organized consumer focus groups in China, according to Morningstar’s Canavan Ward. Nike has almost tripled since the fund first purchased shares of the Beaverton, Oregon-based company in the second quarter of 2009.
In 2008, the Touchstone fund fell 48 percent, trailing 95 percent of rivals. While expressing frustration with the results, the firm told shareholders there were reasons for optimism. In the annual report for that year, Touchstone referred to the “extreme” mismatch between the fundamentals of the companies they owned and market prices.
“Extraordinary events can often lead to extraordinary opportunity,” the firm wrote. “We believe that we are in the midst of exactly such a situation.”
Starbucks and Amazon, both based in Seattle, have been in the portfolio since 2008, accounting for 2.8 percent and 7.8 percent of the fund’s assets as of June 28, respectively.
Salesforce.com, a San Francisco company whose shares have quadrupled over five years, has also been in the fund since 2008. Salesforce.com, which makes customer-management software, rose as much as 14 percent on Aug. 30 after the company issued third-quarter sales and earnings forecasts that topped analysts’ estimates. The company accounted for 5.8 percent of the fund as of June 30.
Visa Inc., the world’s biggest payment network, based in Foster City, California, has tripled over the same five-year stretch.
The fund has found winners in biotechnology. Regeneron Pharmaceuticals Inc. was purchased in the third quarter of 2011, just before the Tarrytown, New York-based company won U.S. approval for Eylea, a drug that treats one of the leading causes of blindness in the elderly. Regeneron has risen more than fivefold since Sept. 30, 2011, according to data compiled by Bloomberg.
Alexion Pharmaceuticals Inc. has more than tripled since it first appeared in the portfolio in the third quarter of 2010. The Cheshire, Connecticut-based company makes a treatment for rare blood diseases.
“We believe the biotech industry is experiencing a renaissance in the development of treatments for rare diseases,” the firm wrote in a first-quarter 2013 letter to shareholders.