The Year's Top Stock Picker Didn't Follow the News
The No. 1 U.S. stock picker of 2016 paid scant professional attention to the biggest event of the year, the presidential campaign that led to the election of Donald Trump. He focused instead on finding small companies with enough underappreciated strengths to prosper no matter who's in the White House or managing economic and interest-rate policy.
He is J. David Wagner, vice president at Baltimore-based T. Rowe Price Group and manager of the T. Rowe Price Small-Cap Value Fund. It returned 30 percent, more than double the Standard & Poor's 500 Index and better than the Russell 2000 Index or the S&P Midcap 400 Index. Among the 156 U.S. non-indexed mutual funds with assets greater than $5 billion -- making them accessible to institutions and individuals alike -- Wagner's fund was No. 1, according to data compiled by Bloomberg.
Even in a good year for shares of small and mid-size companies, Wagner's fund stands out. Of the 44 funds investing only in small or mid-cap stocks, his was the best of 13 that beat a strongly performing benchmark.
Wagner's winning strategy depended on identifying companies too small for most analysts to acknowledge. Yet his fund avoided the price swings of competitors with a similar approach, giving it a volatility rating 10 percent lower than the average of its peers.
For the second consecutive year, the top stock picker is a practitioner of the valuation model introduced in the 1930s by Columbia University professors Benjamin Graham and David Dodd. The model considers earnings, dividends, cash flow and book value in pursuit of companies trading at less than their net worth. The 2015 winner, the Fidelity Select Retailing Portfolio, returned 19 percent that year among the 563 actively-managed equity mutual funds with a minimum of $1 billion and at least 80 percent invested in the U.S. It easily beat its peers and vanquished the S&P 500's 2.2 percent advance last year. The same fund trailed the S&P 500 this year, however, returning 6 percent and demonstrating that one year's winning strategy can be another year's mediocre one.
Some of Wagner's largest gains were in health-care stocks, which enriched his investors despite representing the most underweighted industry in the fund at 6.2 percent compared to the 14 percent benchmark for similar funds. While the benchmark lost 6 percent, T. Rowe's health-care shares returned 22 percent, outperforming the benchmark by 28 percentage points, according to Bloomberg data. Among the winners: Lantheus Holdings Inc., the North Billerica, Massachusetts-based developer and manufacturer of diagnostic medical imaging agents with a market capitalization of only $305 million, appreciated 146 percent; WellCare Health Plans Inc., the Tampa, Florida-based managed care company, rose 76 percent; Lionville, Pennsylvania-based West Pharmaceutical Services Inc., which climbed 42 percent; and Allen, Texas-based Atrion Corp., the maker of medical products and diagnostic equipment, gained 33 percent.
Since the Affordable Care Act took broad effect in 2013, American health-care companies outperformed every U.S. industry through July 2016. "Health care has been on a fantastic tear since the ACA was passed, so it's been tougher and tougher for us to find stocks that look undervalued or cheap," Wagner said in an interview earlier this month. While health-care stocks don't look particularly cheap relative to those of financial or energy companies, T. Rowe increased its holding of Lantheus because "investors aren't focused on it and they don't demand a lot of attention from Wall Street analysts."
Similarly, he said, "Wellcare is a Medicare/Medicaid payer just benefiting from the surging growth surrounding the adoption of Medicaid and expansion of Medicare and Medicaid programs in various states." The company is "a beneficiary of the explosion of enrollment associated with the Affordable Care Act." He was referring to the people signed up for health insurance for 2017 on the federal exchanges created by the 2010 law; the Department of Health and Human Services estimates 13.8 million people will have signed up nationwide by early next year.
Wagner, who has a B.A. in economics from the College of William & Mary and an M.B.A. from the University of Virginia, turned 42 in February and spent all but one of his 17 working years as an investment analyst at T. Rowe Price. He credits his success to "a large team of analysts we have to pick small companies that we think are undervalued, and we can own them a long time." He said his fund puts a "heavy emphasis on long-term ownership and high quality companies" and the purchase of shares "when they look really cheap."
The T. Rowe Price Small Cap fund was most prescient in its holding of financial companies, the largest percentage of the fund at 26 percent and more than 8 percent greater than the industry benchmark. Wagner's team let its weighting in financial shares increase from 25 percent in the third quarter before the small-cap financial stock index rose 10 percent during the past two months. Regional banks and community banks, including Home BancShares Inc, Proassurance Corp. and East West Bancorp Inc., are the fund's largest holdings. Since the financial crisis of 2008, banks contended with a combination of credit stress, increased capital requirements, regulatory oversight, a slow-growing economy and low interest rates.
"You put all that together and it's a formula for very cheap stocks, very out of favor, a lot of negative sentiment and then a period of very poor performance," Wagner said. "And if you look over the last decade that ended in February this year, I would wager to say banks have been one of the worst-performing groups. So we just found a lot of cheap stocks and we've been steadily adding them."
While the past two months, when the S&P 500 gained 6 percent, were a boon to the performance of Wagner's fund, he says he wasn't thinking about the presidential election. "We're not in the prediction business, particularly around politics and even around markets; we don't have much of a view," he said. "If you were to describe the market since the election as a Trump rally, I think it's a little bit of a misnomer. Just the fact the election is over is a big driver. So even if Hillary had won, I wager to say the market probably would have risen."
As for his biggest bet on the financial industry, Wagner says it's not unusual to benefit from unforeseen events like Trump's victory. "It's not uncommon for us to get paid in unexpected times in unexpected ways," he said. "You own something that you keep with the idea that over time it will be re-rated, but you don't know what the catalyst will be. I'm looking smart, but I can tell you it didn't feel smart eight months ago. It felt pretty crummy."
(With assistance from Shin Pei)
The 2016 rankings aren't directly comparable to the preceding year's because of changes in methodology. This year's tally was limited to funds with at least $5 billion under management, eliminating hundreds of funds with fewer investors and lower risk-adjusted returns. The higher limit makes the ranking more relevant to institutional investors, who are often unable or unwilling to participate in smaller funds.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
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