For today's fund screen, we went looking for no-load stock funds that own stocks with above average earnings growth potential combined with below average price valuations. This investment philosophy is called growth at a reasonable price (GARP). It's basically a value approach to buying earnings growth. If you've ever played golf, you know that if you swing too hard the chances of your ball landing in the rough or out of bounds is increased. These funds take a little off their swing in an effort to land the ball in the middle of the fairway.
Specifically, we screened for stock funds that had an average earnings growth rate higher than the S&P 500 Index along with an average price-to-earnings (P/E) ratio lower than the S&P 500 Index. Note that funds can achieve these averages in one of two ways. Some funds blend safer stocks with riskier ones, while others fish mainly in GARP waters.
Next, we looked for those with solid 5-year risk-adjusted performance. Morningstar has a thing called Morningstar Return and Morningstar Risk that tells you how funds performed relative to all stock funds, rather than just their fund category. We like analyzing return and risk this way, since category performance varies. Here we set a high threshold, screening for funds that had Morningstar Returns of 1.50 or better and Morningstar Risks of 0.75 or lower. If you assume the average fund is 1.00, we're basically saying that we screened for funds that have done 50% better than their stock fund peers, with 25% lower risk than their stock fund peers. We want stock funds that can maximize returns while minimizing risk relative to their peers, the winning combination.
After that we looked at the fund's management, to see who has managed the fund and for how long. Here we set the standard of five years, so that we would know that all of the fund performance, risk and portfolio statistics were attributable to the manager. Too often, investors buy funds based on past performance and don't realize that the manager who put up the numbers has left and a new, untested manager is at the helm. Finally, we followed up with a little qualitative work of the fund's management to get a sense of their education, experience, philosophy, etc, to ensure that the fund had sound investment management.
The last thing we did was look at loads and expenses. Here we wanted funds that were true no-load funds, meaning that they did not have an up-front load fee, deferred or back-end load fee, or 12b-1 advertising fee. In addition, we screened for funds whose annual expense ratio is below average (somewhere in the range of 1.00% or less). Our feelings are don't pay loads if you don't have to and don't pay more than 1.00% in annual expenses if you don't have to. Low expense means you get to keep more of the fund's return, since expenses are deducted from gross return. Note the average stock fund's annual expense ratio is 1.44%.
Our screening process resulted in two offerings we feel have appeal to both risk conscious investors and those seeking high returns - Selected American (SLASX) and Buffalo Equity (BUFEX). You may know the Selected American Fund because it's fairly large at $5.7 billion, and its fund manager, Christopher Davis is a regular guest on CNBC (Davis also runs the highly successful Davis New York Venture Fund). The Buffalo Equity Fund is much smaller at $41 million, but small can mean nimble, so it's not necessarily a negative. We were impressed the more we dug into the fund, and we think you will also.
Oh yeah, did we mention that both funds beat the S&P 500 Index by wide margins over the trailing 5-year period ended 1-31-01?
Selected American (SLASX)
5-Yr M-Star M-Star 3-Yr % P/E Market Mgr Exp
Return Return Risk Growth Ratio Cap Tenure Ratio
SLASX 22.1% 1.96 0.75 23.7 25.1 $61.2B 5+ Yr 0.93%
Peers 15.6% 1.00 1.00 19.3 31.5 $31.4B 3.6 Yr 1.45%
S&P 500 18.4% -- -- 17.5 31.3 $65.2B -- --
5-year return is annualized (averaged). Morningstar data through 1-31-01
Christopher Davis, who manages this $5 billion fund and the $20 billion Davis New York Venture Fund, is the third generation of a Davis family that has its roots on Wall Street. His grandpa died with $850 million, amassed by being a true penny pincher. If you go to their site, Davis tells the story of how when he was young he asked his grandfather for a dollar to buy a hotdog, and his grandpa replied "Do you realize that if you took that dollar and invested it at 15%, when you are my age that dollar would be worth $1,000?" From that, Davis learned as he puts it the importance of not overpaying and the power of compounding. These are the hallmarks of the Davis investment philosophy.
Naturally, Davis' grandfather taught his Dad, Shelby Davis, the tricks of the trade. His father went on to enjoy fame and fortune of his own as the founder of Davis Selected Advisers L.P., the investment company which runs the family's two flagship funds, Selected American and Davis New York Venture. After school, Chris joined his father at the firm, and about five years ago after Chris had honed his skills, his father turned over the reigns, and retired.
So far, he has filled his father's shoes very nicely, posting a 22.1% average annual return for Select American over the trailing five years, 3.7% better than the S&P 500 Index and 6.5% more than the average stock fund. How does he do it? Davis looks for companies with quality management, strong balance sheets, strong returns on capital, lean operating budgets, dominant or growing market share, growing earnings and other factors, all at an attractive price. He also loves to grab growth companies after they get derailed and can be picked up cheaply.
The end result is portfolio that has the solid reliability of larger, value stocks such as banks and financial companies, with some exposure to technology and other high earnings growth stocks. Davis' ability to grab growth companies after they get derailed is one of the key drivers of the fund's performance. Because he takes a long-term view, Davis is winning to ride it out until the stock rises back up to its true value. Since value stocks typically have less volatility than high flyers, his portfolio is less volatile than the average stock fund.
As Morningstar puts it "This is one of the best" and I won't disagree.
If you're interested in this fund, you should visit the Selected Funds
web site at www.selectedfunds.com.
Buffalo Equity (BUFEX)
5-Yr M-Star M-Star 3-Yr % P/E Market Mgr Exp
Return Return Risk Growth Ratio Cap Tenure Ratio
BUFEX 20.2% 1.69 0.69 19.3 26.5 $28.0B 6 Yr 1.05%
Peers 15.6% 1.00 1.00 19.3 31.5 $31.4B 3.6 Yr 1.45%
S&P 500 18.4% -- -- 17.5 31.3 $65.2B -- --
5-year return is annualized (averaged). Morningstar data through 1-31-01
Portfolio management of the Buffalo Funds is provided by Kornitzer Capital Management Inc., of Shawnee Mission (KS), a respected name in investment management. While they're relatively unknown in the mutual fund world, Kornitzer manages over $1 billion for insurance companies, corporations, pensions, colleges, and foundations, and is starting to make a name for themselves. Earlier in the year they were profiled in Investor's Business Daily, for example. The reason why is the firm's solid performance since they launched the Buffalo Equity Fund in 1995. You can see for the table above that they've gained over 20% per year for their shareholders, almost 5% better than the average stock fund and almost 2% better than the S&P 500 Index.
The lead manager of the fund is Tom Laming, who has over 10 years of investment management experience and is the fund's original portfolio manager. Prior to joining Buffalo, Laming was a technology analyst at Waddell & Reed, a prominent investment shop, before that a spacecraft engineer for TRW and Martin Marietta. In my experience, I have come across many engineers turned investment managers, and they have good analytical skills that are required to be an effective fund manager. He fits in nicely with this research-driven firm, which scrutinizes industries and the companies in which it invests.
In stock selection, Laming maintains an active list of 350 blue chip companies. Prior to being added to the list, each company undergoes thorough fundamental analysis. A detailed corporate file is built, then personal contact is made and maintained with company management and various industry sources and analysts. From the list of companies, core equity holdings are chosen based on the overall economic outlook, the companies' industry and the current value of the companies' stock. Like Selected American, this fund searches for investment value among high growth stocks, buying them when they can get them cheap.
One of the differentiating qualities of the firm is its thematic view. They look at broad trends in demographics and technology, such as the aging population and greater bandwidth, and then seek to find stocks that can benefit from that theme. Like Davis at Selected American, Laming takes a longer-term view in making decisions, and is patient. Low turnover and low expenses help this fund rise to the top, along with solid discipline and good stock selection. And, since the fund has only 40 holdings, Laming gets to know his companies very well.
Investors seeking a core stock investment have a fine choice here. For
more, go to the Buffalo Funds web site at www.buffalofunds.com.
