Relentless Search for Growth Humbles a Mutual Fund Star
"…Mr. McCall has compiled one of the worst investment records of the new century with that money. All but about $650 million has been lost, leaving shares that cost many Merrill customers more than $10 each worth slightly more than $2. "
August 23, 2001
By PATRICK McGEEHAN
From The New York Times
James D. McCall was one of Wall Street's best stock pickers in the late 1990's, his hand so hot that Merrill Lynch, eager to revive sales of its mutual funds, paid a ransom to his previous employer to win his services.
Starting early last year, Merrill's brokers collected more than $1.5 billion from their clients for Mr. McCall to invest.
But in a breathtaking reversal of fortune, Mr. McCall has compiled one of the worst investment records of the new century with that money. All but about $650 million has been lost, leaving shares that cost many Merrill customers more than $10 each worth slightly more than $2.
As of Tuesday, Mr. McCall's main fund, Merrill Lynch Focus Twenty, held the rare distinction of ranking in the bottom 1 percent among funds of its kind for the previous day, week, month, quarter and year, according to Morningstar Inc., a company that analyzes mutual funds.
Though Mr. McCall is free to invest anywhere in the stock market, he has stuck to a growth-seeking strategy that kept the fund invested primarily in technology stocks throughout that sector's long, steep decline. Down almost 80 percent in the last year, the fund's performance has been significantly worse than that of the average technology fund, let alone its peer group of
more diversified funds. It did, however, register aggressive gains in two market rallies.
Lately, the Focus Twenty fund seemingly went from bad to cursed as some of Mr. McCall's favorite stocks were laid even lower by a series of unfortunate surprises. His bigger holdings include Enron , whose shares fell 8 percent after
its chief executive suddenly resigned, and Ciena , which dropped 30 percent in a day on disappointing earnings.
"It has been a miserable week," Mr. McCall allowed in an interview on Tuesday. "It's not easy managing a portfolio like this in this type of an environment."
Mr. McCall's rapid rise and fall demonstrates how fleeting stock- picking stardom can be, said John C. Bogle, founder of the Vanguard Group mutual fund company. Too often, Mr. Bogle said, investors chase after the past returns of the fund manager of the moment, only to find out they were pursuing a "comet." (Investors in Vanguard's own aggressive growth fund,
Vanguard Growth Equity, have had their shares drop 53 percent in value from their peak 17 months ago.)
Still, Vanguard is known for its index funds — the antithesis of Mr. McCall's stock-picking discipline — and Mr. Bogle is indexing's most outspoken champion. In speeches around the country, he has repeatedly and coyly — avoiding any mention of Merrill's name — cited the giant brokerage firm's creation of Focus Twenty and another fund in March 2000 as an
example of racing to cash in on the latest market fad.
In roughly five weeks, Merrill's brokers gathered a total of more than $2 billion for Focus Twenty and the Internet Strategies fund. Almost immediately, those funds collapsed along with the Internet and technology stocks they owned. Internet Strategies, which Mr. McCall does not manage, never recovered and has now lost more than 80 percent of its value; Merrill
plans to merge it with another of its stock funds.
But Mr. McCall, 47, said his fund did not face a similar fate. Indeed, he said, Robert Doll, the chief investment officer for Merrill's funds, recently told the firm's brokers that Merrill was committed to Focus Twenty and its aggressive, concentrated style.
Mr. Doll was not available for comment, but Merrill confirmed Mr. McCall's account. "We are committed to having a full range of investment styles, aggressive growth being one of them," said a spokesman, Erik Hendrickson.
Funds seeking to rack up market- beating returns by making big bets on as few as 20 stocks proliferated in the late 1990's, in part because of Mr. McCall's success managing the PBHG Large Cap 20 fund for Pilgrim Baxter, a fund company in Wayne, Pa. In the two and a half years Mr. McCall ran it, the PBHG fund ranked first among its peer group — funds that
buy stocks of large companies whose earnings are expected to grow quickly — with average annual returns of more than 50 percent.
It was those knockout numbers that brought Merrill calling in its search for proven growth-fund managers to broaden the firm's value- oriented lineup of funds. After Mr. McCall accepted Merrill's job offer, Pilgrim Baxter sued to stop him from breaking his employment contract. Mr. McCall countersued, and Merrill later agreed to pay an undisclosed sum to settle the
litigation.
In court papers, Pilgrim Baxter disclosed that Mr. McCall had earned as much as $1.5 million annually there. Mr. McCall and Merrill officials have repeatedly declined to reveal how much the firm paid Pilgrim Baxter or any details of Mr. McCall's compensation at Merrill. Often, however, investment returns affect the pay of fund managers.
Like Focus Twenty, most of the concentrated funds sank last year with the collapse of technology stocks. The managers of some of those funds, including Marsico Focus, have shifted money out of volatile technology and telecommunications stocks and into more mature companies, like Citigroup (news/quote) and Omnicom, which owns ad agencies.
Mr. McCall sniffed at some of those choices, saying that the fund managers were not staying true to their mission of aggressive growth investing.
"I'm not going to own an Omnicom," he said, "or a Sony (news/quote) or a Viacom (news/quote) or General Dynamics, because they're growing in the single digits." Thomas Marsico, the manager of Marsico Focus and one of the original concentrated-fund managers, did not return a call seeking comment.
Mr. McCall said he would continue to try to identify the companies that have the best chance of increasing their profits at extraordinary rates, regardless of what value other investors are assigning to those prospects at any given time.
"Valuation is not one of the factors that enters into our methodology," Mr. McCall said.
About 70 percent of Focus Twenty's assets are in technology stocks, according to Morningstar. But the fund's biggest holding now is Idec Pharmaceuticals, a drug maker.
Kunal Kapoor, a Morningstar analyst who tracks Merrill's funds, calls Mr. McCall a momentum investor who seeks "growth at any price." Mr. McCall may be the best investor of that stripe, Mr. Kapoor said, but the strategy is so risky that he questions whether it was ever appropriate for so many of Merrill customers.
"I was really surprised by the amount of funds they were able to raise for a fund like that in such a short time," Mr. Kapoor said. "The question is: Do you really need a fund like this?"
Reading a prepared statement, Mr. Hendrickson said Merrill Lynch considered concentrated funds to be "an appropriate option" for some investors, because they "maximize the impact of professional stock- picking over the long term and additionally may serve as an alternative to individual stock holdings."
He pointed out that Merrill managed another concentrated fund, Merrill Lynch Focus Value, that had performed well this year, gaining more than 3 percent.
As for Mr. McCall's returns, Mr. Kapoor said he could not fault Focus Twenty because it had performed as would be expected for a fund of its composition. It rang up some of the biggest gains of any fund in two brief periods when the market picked up — the third quarter of 2000 and April of this year — and some of the biggest losses when the market was down.
Rather, he said he was more disappointed with the other fund Mr. McCall manages, the Merrill Lynch Premier Growth fund, which is supposed to be less volatile because it holds about 50 stocks. That fund is down more than 50 percent this year and has shrunk to less than $100 million in assets.
Mr. McCall said that he had warned Merrill's brokers all along just how volatile his returns could be and that Focus Twenty
was no place for investors to put money they might need any time soon.
But, he said, he thinks that now, more than ever, is the time to take a chance on the fund, with its shares selling for about $2.20.
"I don't think $2 a share is a lot to risk," the indomitable fund manager said. "We could go down from here certainly, but over the long term, there is more potential on the upside than on the downside."
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