Jim King, Rydex Healthcare
Rydex portfolio manager Jim King oversees a wide spread of mutual funds – mostly run on a quantitative basis – so getting out and kicking the tires of a business is rare for him. One fund he keeps a close watch on is Rydex’s $45 mn Healthcare Fund, up a bracing 32 percent in 2003 after a grim plunge by around the same amount during 2001 and 2002.
‘Mostly we stick to the numbers,’ says King. ‘We don’t have a large research team, and healthcare is an extremely broad industry with hundreds of companies.’ This means keeping close tabs on healthcare industry trends and changes in regulation, and applying a gimlet eye to the numbers. ‘The regulatory environment,’ King adds, ‘particularly for pharmaceutical companies, changes fast – just look at the issue of buying drugs from Canada because it’s cheaper.’
Brand value is relevant for the Rockville, Maryland-based fund, especially in the healthcare sector. ‘But our philosophy is that markets are already efficient,’ King notes. ‘If companies have a good name, that’s loaded into the price.’ Valuation methods vary, though bottom-line cash flow – particularly given the long development timelines in the drug development market – is crucial. When projecting figures ahead, King and his team put much store by analyst consensus and past data. But the heaving reams of information spewed out by the internet mean company annual reports are now shrinking in importance, he says. ‘The only reason now for annual reports is to get wind of industry trends, such as prescription drug reform,’ he adds. However, other Rydex funds are more reliant on traditional research methods.
Corporate social responsibility (CSR) and corporate governance are both low on King’s agenda, which he puts down to the quantitative methods he works by. ‘We try to make money on additions or deletions [on the Rydex index funds] but any motivation would be due to technical factors,’ he explains. The ongoing mutual fund furor has, he claims, bypassed Rydex, and he’s now hoping to bag more assets at the expense of those who have been tainted.
Meanwhile, late trading and market-timing policies have been installed. ‘All our shareholders have equal opportunity to move in and out of funds,’ King comments. ‘The flow of funds tend to be large, so consequently we’re very strict on cut-off times.’ He reports little worry from investors on the subject – the phone has been quiet, helped by regular web site updates.
But working up an enthusiasm for proxy vote disclosure is plainly hard work. ‘Overall, full disclosure would be cumbersome and expensive for the industry and, subsequently, for shareholders,’ King says. ‘I also believe that shareholders would likely get small benefit from knowing how their shares are voted. It’s not clear to me whether the benefits justify the costs.’
Christopher Baggini, Gartmore US Growth Leaders Fund
A 53.9 percent rise in fund value was a handsome finish to Chris Baggini’s 2003. But Baggini, who co-manages Gartmore’s $24 mn US Growth Leaders Fund – a multi-cap with a core 20 to 30 US stocks – had ground to make up after 2001/2002, when holdings fell 37 percent. Last year’s bounce now puts him 15 percent up overall, boosted by a generous helping of portfolio tech stocks that have reloaded in value. ‘Currently we’re pretty overweight in technology – around 38 percent of our fund. It’s where we think the best ideas are,’ Baggini explains.
It’s also where a lot of trouble-shooting is. Last year saw a string of worldwide virus outbreaks, which helped security software firm Symantec – one of Baggini’s biggest holdings – rake in plenty of new business. ‘[Symantec] has by far the largest market share and a lot of new product cycles on the way,’ Baggini says. ‘Security is now very integrated into corporate spending.’
Given the choice, he would always opt for one-on-one meetings. ‘We saw Symantec ten times last year, face-to-face,’ he notes. ‘What we want to know from these discussions is the rationale behind the ownership position. We want a clear sense of what’s driving its business model, what management is thinking.’ Baggini’s spreadsheet math, when focusing on reconciling income statements, is set against balance sheet changes. ‘What’s the impact,’ he asks rhetorically, ‘on inventory levels changing dramatically? What’s going on with competitors and suppliers?’
Media stocks now make up a growing portion of the fund’s holdings, but this sector is notoriously difficult to value accurately, Baggini says. ‘Where any industry has a high depreciation expense – non-cash expenses – trying to reconcile earnings in contrast with other sectors is difficult,’ he admits. He also complains that annual reports are increasingly of limited value. ‘There’s too much fluff,’ he says. ‘We want direct facts – the 10Qs and 10Ks are much more relevant. Because we take such big bets on stocks, we have to know 100 percent what’s going on – 90 percent is not enough.’
Although CSR and corporate governance issues have their place, Baggini puts the emphasis, ultimately, on the bottom line.‘I don’t care if [Walt Disney CEO] Michael Eisner makes $10 mn a year, provided he can make above-industry growth,’ he states.
More money, Baggini hopes, will flow his way on the back of mutual fund industry nervousness – though Gartmore remains untouched, he says. Meanwhile, proxy vote disclosure is something he also has to deal with now: ‘We’ll roll with it, he predicts. ‘It’s an increased cost to our business but if our customers want it, we’ll comply.’
Tom McKissick, TCW Galileo Large-Cap Value Fund
Tom McKissick, portfolio co-manager of TCW’s Galileo Large-Cap Value Fund – one of the mutual fund industry’s performance stars of 2003, and ranked fourth-best performer among US large-cap value funds, according to Lipper – spends little time obsessing over P/E ratios when evaluating potential stocks. Far more engrossing for him is the return on invested capital.
This fund, unlike other value offerings, isn’t afraid of tech stocks or the oft-scorned basic materials sector. ‘We’re now overweight in basic materials,’ says McKissick. ‘We think we’re at the end of the 20-year commodity bear market.’ The bottom line for him in this sector is returns well below the cost of capital, and he’s hoping demand from the booming economies of Russia, China and India will lift his commodity-heavy fund higher. ‘The only genuine debate here is if you bring in all those billions of consumers,’ he notes. ‘That’s why we’re so overweight here.’
He has a suspicion of income statements – ‘they can so easily be manipulated’ – that sees him focusing on how capital gets allocated. ‘What kind of cash is it?’ he asks. ‘If the invested capital increases, we’re interested. Our next question is then, What do we pay for it?’ Worst-case and best-case scenarios then follow. Much preferred one-to-one meetings are vastly outnumbered by daily phone contact, though McKissick and his team get a steady flow of companies coming through his Los Angeles office.
Again – and it’s a constant for this $120 mn fund, up over 35 percent in the last year – it comes down to cash generation, be it through plant, brand or oil well. ‘We’ve seen a lot of dissembling in the last three to five years,’ McKissick says. ‘We’ve avoided headline companies that were putting forward earnings very aggressively – and we’ve avoided many of those that sank.’
In contrast to some other managers, McKissick places great emphasis on annual reports. ‘They’re very, very important,’ he says. ‘The information we’re processing is only as good as we’re given. If you’re given bad input, you’ve no chance. Hopefully we can decipher the information before anything happens. We can’t emphasize enough the value of detailed information.’
CSR doesn’t much rouse his curiosity, though corporate governance gets his blood going. ‘Board changes are very important – far more so than three to five years ago,’ McKissick insists. Incentives also matter, provided they’re linked to shareholder value. ‘There’s nothing wrong in management getting wealthy, provided it’s in proportion to the value created for shareholders,’ he says.
So far, the mutual industry rumblings haven’t hit TCW. Late trading and market-timing trades remain strongly discouraged. ‘We have redemption fees on international funds to stop people jumping in and out,’ McKissick explains. ‘We’ve also frozen more than 300 accounts that were, we believed, excessively trading.’
George Mairs, Mairs & Power Growth Fund
George Mairs, the 75-year-old president of the Minnesota-based Mairs & Power Growth Fund, has a track record most fund managers would kill for. In the last ten years this $1.3 bn fund has returned an average 17 percent a year. True, it had a rare 8 percent dip in 2002, but a 26 percent hike in 2000 more than helped offset this. And last year Mairs was up a further mighty 26 percent. This long-tenured manager’s secret? Buy cheap, stay local.
‘We have only 35 stocks,’ he explains. ‘We have a low turnover and concentrate on upper mid-west companies. I like to think it’s our ability to talk to them directly that’s been a factor in our success.’
Stocks held are multi-cap, but Mairs likes to get in early when companies are small, buying opportunistically. Brand values have limited appeal, though, as Mairs is much more interested in franchise arrangements. ‘Because we want to hold a stock for ten to 20 years, we want long-term sustainable growth,’ he explains. ‘So we’re interested – and General Mills [a Minneapolis-based food company] is a good example here – in the service it provides.’ Predictability isn’t so important, he adds, but sustainable earnings and revenue are.
Market domination matters, too. Mairs mentions one stock the fund holds: Ecolab. ‘This company, two blocks away, was started by the grandfather of a friend of mine in the 1920s,’ he says. ‘Today it’s the largest producer of sanitizing products in the world. Recently it added to its arsenal of products and got into janitorial items. It’s selling to the Marriott chain and Hilton Hotels; these companies would rather deal with a single vendor.’
Meetings with company management are regular. ‘More often management comes to see us at the twin cities [Minneapolis-St Paul], typically bringing the CFO and CEO,’ Mairs explains. ‘We want to face them directly – you can learn something from the ease and lack of ease of body language, to have some sense of what they’re about.’
Corporate governance is very much a headline issue for Mairs. ‘It’s a reason to visit management, to pay attention to the board,’ he notes. ‘Also, the [management’s] presumed independence – very important. We want to see quality people with some expertise in whatever the company’s basic business is.’
Financial models that Mairs favors vary, but he’s keen on a high return on invested capital and equity. ‘We like top-line growth but you can’t do bottom and top-line together all of the time,’ he says. Although the fund’s range of stock stalwarts is rarely sold, Deluxe Corp – a check-printing company that was having problems diversifying out of its core business – was recently given the push.
In common with some other managers, Mairs says he’s made ‘modest’ gains from the ongoing mutual fund drama. ‘We’ve always screened new shareholders of any size to make sure they’re not short-term traders – we don’t want anyone who’s not going to hold for at least one year,’ he explains. ‘As a portfolio manager, that makes my job more difficult.’ He is also keen to make life tough for potential shorters – fax and telephone redemptions are banned.
Client disclosure is unusually frequent. ‘We’ve always issued quarterly results,’ Mairs says. ‘The SEC doesn’t request it but we feel we’ve led the industry here.’ And proxy vote disclosure doesn’t faze this veteran fund professional one jot. ‘We’re perfectly willing to disclose on how we vote on these proxies,’ he declares. ‘It’s not an issue, and we’re happy to comply.’
Mairs has managed the fund, started by his father, for over 23 years, but he has recently handed much of the fund’s running to a younger man – eleven years younger, to be exact. Stock allocation will now fall to 64-year-old William Frels, who is rumored to be even more painstakingly systematic in his investment philosophy than his predecessor.
