Individual Investor
Value Funds that Harness Technology's Growth
By: Judith Graham (06/02/00)
If you're into value investing, be bold about it. One manager says value funds that carry the minimum possible risk offer little real value.
``If people are simply going to manage to the value benchmark, [their funds] should just be indexed,'' says Jerome Heppelmann, manager of PBHG's value funds. ``You're not adding a lot of value if you're seeking to match the benchmark.''
That said, among those stocks Heppelmann has recently been buying and selling are tech stocks. Unlike some value fund managers, Heppelmann believes in including technology stocks in his fund portfolios. He likes tech for its strong earnings and momentum.
``We don't shun technology, which separates us from some of our value peers,'' Heppelmann says. ``Tech is part of the benchmark we need to beat. It's an important part of the economy. It's driving productivity.''
As noted, Heppelmann's value funds don't always comply with the traditional rules of value fund management. They include the $86 million PBHG Small Cap Value fund (NASDAQ: PBSVX - news), the $52 million PBHG Mid Cap Value fund (NASDAQ: PBMCX - news) and the $30 million Focused Value fund (NASDAQ: PBFVX - news).
And based on his funds' returns, breaking the rules seems to be working just fine. PBHG Small Cap, whose 120 or so holdings have a market cap of $2 billion or less, has returned 17.13% year-to-date through Wednesday.
PBHG Mid Cap, which holds about 70 stocks with market caps between $1.5 billion and $8 billion, has also returned 17.13% during the same period. And the more concentrated Focused Value, which invests across all market caps but is limited to about 35 or so stocks, has returned 18.33% for the year-to-date.
Applying the same investment strategy to all three funds, Hepplemann wants to outperform the Russell 2000 Value and the Russell 2000 indexes by managing sector and market cap diversified portfolios. He considers each potential holding's balance of long-term growth, near-term business dynamics and valuation, then typically buys stocks with above-average earnings growth, but trading at below-average valuations.
``Below average,'' however, doesn't mean scraping the bottom of the barrel, Heppelmann explains. ``Most value funds buy the cheapest stocks with the lowest P/Es,'' he says. ``But low P/Es often indicate detrimental fundamentals.''
Attesting to Heppelmann's affinity for tech, the Russell 2000 carried a 25.1% tech weighting in April. Currently, technology accounts for about 20% of his portfolios. The Small Cap fund includes tech names such as Sonic Foundry (NASDAQ: SOFO - news) and Glenayre Tech (NASDAQ: GEMS - news), and Mid Cap offers tech holdings like Network Associates (NASDAQ: NETA - news).
Focused Value boasts Comcast (NASDAQ: CMCSA - news) among its tech holdings. With the recent market downtrend, semiconductor equipment stocks may emerge as candidates for the Small Cap and Mid Cap funds, Heppelmann says. He's currently eyeing Cypress Semiconductor (NYSE: CY - news) and Integrated Device Technology (NASDAQ: IDTI - news).
So while Heppelmann isn't trying to grab growth stocks trading at 50 times earnings, he's also not limiting his portfolios to stocks that carry the lowest multiples. To find stocks that match the criteria for his funds, he first eliminates the 25% most overvalued and the 25% most undervalued stocks. From there, he weighs a company's long-term growth potential with the valuation it commands in the market.
Additionally, both quantitative and fundamental analysis is used to select stocks for the funds' portfolios. However, Heppelmann stresses that his funds shouldn't be considered quantitative funds. ``Quantitative analysis is a productivity enhancer,'' he says. ``It's like a good hunting dog - it's great to go hunting with, but you don't give it the gun.''
Given all the variables Heppelmann weighs in his stock-picking process, he says the changes he makes to the Small Cap, Mid Cap and Focused funds are fairly rapid - particularly in light of the past few months' market volatility. Heppelmann's current strategy is to sell into strength as the market rallies and buy stocks that were too expensive - often the better fundamental names - when it comes back down.
Heppelmann also likes energy - the sector in which his funds are most over-weighted. He says the energy sector's solid long-term growth, positive near-term business dynamics, and low valuations make it a compelling investment area. He's particularly bullish about natural gas. Some of his favorites include EOG Resources (NYSE: EOG - news), Weatherford International (NYSE: WFT - news), and Baker Hughes (NYSE: BHI - news) in the oil services area.
However, one area from which Heppelmann tries to distance himself is Real Estate Investment Trusts (REITs). While the Russell 2000 is about 10% weighted in REITs, Heppelmann relegates REITs to a very small part of his portfolios. He views REITs as a safer fixed income investment. ``There's no deep value investment [in REITs] - we give up some safety in that sense,'' he says.
While Heppelmann recently lightened his funds' financial positions, he still likes Fleet BancBoston (NYSE: FBF - news). Trading at roughly nine times earnings, Fleet BancBoston offers solid long-term growth due to its northeastern location and continues to benefit from the merger (between Fleet and BancBoston) that created it last October. Greater-than-expected cost cutting synergies and ramping credit card business are among its catalysts for growth, Heppelmann says.
Amid the current volatile market, Heppelmann says he tries to maintain broad diversification with stocks like Allstate (NYSE: ALL - news) , which he finds compelling at 9.9 times earnings. He says Allstate's business is starting to turn around, and it could emerge as a takeover target.
Lastly, Heppelmann likes S3 (NASDAQ: SIII - news), a graphics chip designer, which he considers his most ``off the radar'' holding. He says he's still building a position in S3, but finds value in its hidden assets, such as its stake in UMC Electronics (NASDAQ: UMCE - news) .
Bottom Line:
Heppelmannshuns traditional value investing styles while making bold moves that pay-off in higher returns. Investors looking for a more strenuous take on value investing may want to consider one of the PBHG value funds listed here. |
