The mutual funds generally considered to be among the most risky -- concentrated funds -- have managed to stay above water while the Nasdaq composite and Dow Jones industrial average are down for the year.
An analysis of the approximately 291 funds with 40 or fewer holdings has shown the average year-to-date return through April 30 is about 2.1%, according to data supplied by Morningstar Inc., Chicago. While not spectacular, it bests the Nasdaq composite, which was down 5%, the Dow, down 6%, and the Standard & Poor's 500 stock index, down 2% through April 30.
Inflows into concentrated funds have increased steadily in recent years -- from $3.1 billion in 1997 to $11.9 billion in 1998 to $14.9 billion in 1999, according to Strategic Insights Mutual Fund Research and Consulting LLC, New York. But $2 billion has flowed into concentrated funds through February of this year, which is off last year's pace.
Still, Brad Lawson, senior research analyst at Frank Russell Co., Tacoma, Wash., said the recent market volatility, which has affected all segments of the market, hasn't scared off many pension funds from concentrated funds.
New accounts
In fact, TCW's Concentrated Core Equity Portfolio landed six new accounts in the past 12 months, Turner Investment Partner's Concentrated Growth portfolio has signed on five pension funds since June 1999, and the Oakmark Select Fund has won three new institutional accounts this year.
Because concentrated funds invest in relatively few stocks, they are subject to short-term volatility.
With fewer stocks in a portfolio, "you don't have that much diversification. And more often than not you have stocks of a similar, if not the same, sector," said Ramy Shaalan, mutual fund analyst at Weisenberger Thomson Financial in Rockville, Md.
In a late 1999 study, Weisenberger found most of the concentrated portfolios were from larger complexes with more resources for research.
"Because you are putting fewer eggs in your basket," said Mr. Shaalan, "you have to be sure that they are the best eggs."
If not, the results could be disastrous. Just look at the Gintel Fund, which is down 26.7% year to date through April 30. It holds 12 stocks, including its top-weighted one, Checkfree Holdings Corp., which represents 26.7% of the fund. Checkfree Holdings is down 51.3% year to date through April 30.
On the other end of the spectrum is the Frontier Equity Fund, which is up 28% through April 30. The fund holds just 11 stocks, including Mitek Systems Inc., which makes up 17% of the fund. Through April 30, Mitek is up 36.2%.
Approaches differ
Among institutional offerings, the concentrated portfolios that have performed well this year have had different approaches.
Glen Bickerstaff, portfolio manager of the TCW Concentrated Equity Portfolio, likens his strategy to baseball. "We like to only swing at the pitch that we think is right down the middle," he said.
Mr. Bickerstaff has managed the TCW Concentrated Equity Portfolio since May 1998, but he has a track record as a concentrated portfolio manager that goes back 12 years -- including 10 with Transamerica Investment Services, Los Angeles. During that time he has had an average annual return of 27% and has outperformed the Standard & Poor's 500 stock index for 10 of the last 12 years. This year Bickerstaff's fund is up 10% year to date through April 30.
Since he took over, the TCW Group's fund has tripled its institutional assets -- to $9 billion. In 1999 the fund landed six pension fund clients, including Sprint Corp., Raytheon Co., General Motors Corp. and Boise Cascade Corp.
Mr. Bickerstaff said he focuses on companies with either a cost structure advantage, meaning they are the low-cost producers or distributors in an area, or a product advantage, which means they have a product that the competition can't replicate -- or both.
"Those businesses tend to be really powerful," he said. The companies he feels are the best get the highest weightings. The top holding in the fund is Dell Computer Corp., which represents 7.3% of the portfolio. Other top holdings are Cisco Systems Inc, at 5.5% of the portfolio, and Kansas City Southern Industries Inc., at 5.1%.
Stringent requirements
With such stringent requirements, Mr. Bickerstaff is selective about the 25-30 stocks he chooses for the portfolio. "It's not that we have to be more selective," said Mr. Bickerstaff; "we get to be more selective."
If the stock doesn't have a competitive advantage it will maintain for the long term or isn't priced at a valuation that makes it compelling down the road, he'll wait for the next one.
"With our selectivity, if we can't have a higher batting average than a broad index of 500 companies, then we're the wrong manager, " he said.
There isn't much turnover in the fund, said Mr. Bickerstaff, even during the recent market volatility. Early this year, however, he took positions in Wal-Mart Stores Inc. and Southwest Airlines Co., two companies he liked and found more attractive as prices came down.
The $3.7 billion Sprint pension fund, based in Westwood, Kansas, recently allocated $100 million to the TCW Concentrated Equity Portfolio. Bill Searcy, pension and savings trust officer at Sprint, said the concentrated portfolio is a good fit in Sprint's equity portfolio, which is 50% indexed, 25% enhanced indexed and 25% actively managed.
"These managers really are the alpha generators. We're taking greater risk with them, but then we complement that with the indexation structure we have, which is kind of our anchor to windward," Mr. Searcy said.
Bob Turner, chief investment officer at Turner Investment Partners, Berwyn Pa., said concentrated funds are used as alternative investments.
"They are very much a non-correlating sort of asset," said Mr. Turner, whose Concentrated Growth Portfolio was picked up by five pension funds, including Raytheon Co., Lexington, Mass., and Crown, Cork & Seal Co. Inc., Philadelphia.
Endowment interest
Mr. Turner believes institutional investors, particularly foundations and endowments, are showing a growing interest in concentrated funds -- "in a market like we're having, perhaps even more interest" than before, he said, because the fund has been able to maintain strong returns in a volatile environment. Year to date through April 30, the Concentrated Growth Portfolio, which is known as the Top 20 Fund in the retail market, is up 15.7%.
All the stocks in this sector-neutral 20-stock portfolio already are owned in one of Turner's other portfolios. The selection process is a matter of finding the best 20 stocks with a near-term catalyst, such as earnings reports, to drive them higher. As a result, the fund has a turnover ratio of about 1,000% per year, said Mr. Turner.
Prior to the March selloff, the fund had more exposure to technology, but scaled back. In April, he said, when it didn't look like technology stocks could go any lower, the management team "ramped up" its technology exposure to about three-quarters of the portfolio. Then as earnings season approached, the fund became more conservative, currently holding about one-third technology stocks.
"Call me back in mid-June and it will probably be filled up with technology companies," said Mr. Turner, in anticipation of the June quarter.
The largest holding in the fund is America Online Inc., at 6.4%, followed by JDS Uniphase Corp., at 5.8%, and Cisco Systems Inc., at 5.7%. Other holdings include retailers Home Depot Inc. and Best Buy Co., which he found attractive because they were oversold, and EDS Corp., which Mr. Turner bought at $60 per share, its previous low, down from $74 per share a month ago. Because he sees EDS' business as strong, he believes the stock can move back up to around $70 per share.
"If I get 10 points on a $60 per share cost basis, that's exactly what I want to accomplish," he said.
The Oakmark Select Fund is different from other concentrated funds in that it is a value fund. Last year, while the value universe struggled, Oakmark Select returned 15.1%. This year the fund has landed three new institutional accounts and is up 4.1% through April 30.
Robert Levy, president and chief executive officer at Oakmark, said the portfolio holds 18 to 22 stocks that are selling at 40% to 50% below what the portfolio management team thinks the business is worth. At the same time, he looks for companies that have a chance to grow. "We avoid the value traps of buying companies that are structurally disadvantaged," he said.
The fund includes a broad representation of industries, from financial services to technology.
"We are careful about our industry concentrations," said Mr. Levy. If the fund already holds one name in a given industry, another won't be added unless it outperforms the first stock, which it replaces in the portfolio.
The top holdings in the fund are USG Corp. at 10.4% of the portfolio and Washington Mutual Inc. at 10.3%. Other holdings include Tricon Global and EDS. The fund has a turnover ratio of about 35% per year, said Mr. Levy. "We think there's a rising appetite (for concentrated funds), and we're well positioned," Mr. Levy said.
Because of the volatility, Mr. Levy believes the concentrated disciplined is better suited to a value approach. A value manager "is buying what ought to be less volatile, less risky securities by definition," he said.
GE Asset Management, Stamford, Conn., has been managing concentrated portfolios on an institutional level for three years and now is bringing those products to the retail mutual fund market. On May 1, it launched the GE Premier Research Equity Fund, the Premier International Equity Fund and the Premier Value Equity Fund, all of which are concentrated.
The firm's flagship concentrated portfolio is the Premier Growth Equity Fund, which debuted in 1997 and currently has $2 billion in institutional assets. Its construction is the basis for the newly launched funds.
The Premier Growth Equity Fund comprises the best four to six stocks chosen by each of the firm's 12 equity analysts. Each analyst selects from one of the 12 different sectors and chooses from a pool of securities the firm already owns through other funds.
"We're drawing on the strength of the organization," said Brendan Gunderson, head of marketing. It is one of just a handful of funds to employ this strategy.
The sector-neutral approach is one of the keys to the portfolio's success, particularly during the recent volatility. The other key is stock selection.
"Don't let anyone tell you otherwise," he said. It was up 21.8% last year and 33.5% over three years. For the year through April 30, the fund is up 1.8%.
The portfolio holds 61 stocks and between 20% and 40% of the portfolio turns over annually.
Mr. Gunderson said it's more important to focus on the long term with concentrated funds -- because of the possibility of short-term volatility -- than with a typical diversified fund.
"We want to make sure that if we're adding risk, we're adding return," said Mr. Gunderson. "You're going to get paid for the risk you're taking."
