Morningstar Advisor - Fall 2007 - (Page 57)

Lynch says that he and his team encounter new investing ideas all the time from their readings and that they can evaluate their current holdings with a keener eye. But beyond that, Lynch says, reading has led them to question common wisdom and to think and rethink how their portfolios, and the team itself, are functioning and constructed. A Different Kind of Manager Every member of Lynch’s team has undergone personality tests, including the MyersBriggs assessment. After discovering that only one person had a “perceiving” personality trait, which, according to the test, identifies people who are “free flowing” and need less structure, Lynch holds a weekly meeting to help other team members get their “inner ‘p’ out.” He wants people to feel free to think out loud. “The idea is just to think about cognitive diversity a little bit, as opposed to having us all be identical,” he says. Lynch is not a typical growth manager, either. Growth is commonly misperceived, he says, and he looks to exploit that misperception. “Growth and value—it’s very arbitrary, especially because it usually winds up being low P/E versus high P/E,” he says. Lynch acknowledges academic studies showing the ability of stocks with low price/earnings ratios to outperform those with high ratios, but he says “that doesn’t mean you can’t find value in the high P/E bucket.” Growth, in his view, is the ability of a company to generate cash and to earn excess returns on invested capital, not the ability to lock in high sales and earnings growth rates at any cost. Looking for healthy cash flows, strong ROIC, and true competitive advantages isn’t a distinctly growth or value strategy, Lynch argues. That style has led Lynch to big positions in unlikely targets for a growth manager. He first started buying shares of oil and gas company Ultra Petroleum UPL in the second quarter of 2003 for his small-cap growth funds. At that time, many growth investors were flocking back to rebounding tech and telecom companies, which were finally rebounding from the dismal bear market. Yet Lynch was drawn to Ultra’s position as a low-cost natural-gas producer. He also liked the economics of Ultra’s gas reserves in the Green River Basin in Wyoming. Most importantly, Lynch recognized Ultra’s ability to earn returns in excess of its cost 20000 of capital early on. Ultra’s stock price went on to gain an average of roughly 70% annually 15000 over the next four years. Lynch structures his analyst team differently, too. Many firms divide responsibilities 5000 along sector or specialty lines; the investors on Lynch’s team are generalists first. He wants his team to keep a broad perspective on competitive dynamics. He points to chemical company Monsanto MON as an example of how it helps to think beyond sectors and industries when investing. “Most analysts look at rules of thumb for that industry,” Lynch says. “When the majority of Monsanto begins to be something else—a monopoly in genetically modified seeds—that is a whole different business with different characteristics and competitive advantages. When these situations arise, a lot of analysts don’t quite know how to deal with it.” Successful picks like Monsanto and Ultra have been many, and investors are noticing. Advisor Gary Beller, of Edward Jones in Omaha, has recommended Van Kampen Mid Cap Growth VGRAX to his clients for years. He appreciates “the consistency of the fund’s returns. It has been a really nice complement to other Van Kampen funds, such as Van Kampen Comstock ACSTX,” he says. A Gradually Evolving Philosophy 10000 Dennis Lynch Van Kampen Pace A ACPAX $20K S&P 500 15 03 04 05 06 07 Category Large-Cap Growth Morningstar Rating QQQ Minimum Investment $1,000 Expense Ratio (%) 0.95 3-Yr Anl Total Rtn (%) 16.69 3-Yr Anl Investor Rtn (%)* 16.29 Investor Rtn Rank Category 14 Stewardship Grade C *Dollar-weighted return that measures how the typical investor in the fund fared. Lynch started managing this fund June 20, 2004. Data as of Sept. 30, 2007. growth fund to Jan-03 Jan-04 leading 13 Van KampenJan-07 Jan-05 Jan-06 and Morgan Stanley growth funds spanning theJun-03 Mar-04Aug-04 Mar-05Aug-05 Mar-06Aug-06inMar-07Aug-07 market-cap spectrum. Feb-03 Jul-03 Feb-04 Jul-04 Feb-05 Jul-05 Feb-06 Jul-06 Dec-06May-07 Mar-03Aug-03 Apr-04Sep-04 Apr-05Sep-05 team Oct-06 Apr-07 Apr-03Sep-03 May-04Oct-04 May-05The Apr-06Sep-06Feb-07 Jul-07 May-03Oct-03 Jun-04 Jun-05 May-06is Jun-06Nov-06 Jun-07 charge of roughly $27 billion in assets. Whether Lynch and his crew are stretched Sep-07 Nov-03 Dec-03 Nov-04 Dec-04 Oct-05 too thin is a legitimate concern. But Nov-05 Dec-05 Lynch thinks the opposite is true. “We have enough people to get the job done,” he says, “but few enough to stay entrepreneurial and not make it about turf wars. We don’t want to be category jockeys; we’re investors.” The team’s investing philosophy is identical across the funds; the only difference is market capitalization and distribution channel. Lynch is constantly retooling the team structure and thinking of ways to be a better investor. He invites change and points to Legg Mason Lynch became a portfolio manager in 1999 when he was in his late 20s. It didn’t take long for the higher-ups at Morgan Stanley to see they had a talented manager on their hands. In eight years, the Lynch team has gone from managing one small-cap MorningstarAdvisor.com 57 http://MorningstarAdvisor.com

Table of Contents Feed for the Digital Edition of Morningstar Advisor - Fall 2007

Morningstar Advisor Fall 2007 Features Departments Letter from the Editor Inbox 10 Years After: Developing Markets Make Progress Research Briefs Investors Should Adjust Their Home Bias Few Mutual Funds Exhibit Serial Correlation Valuating ETFs, the Equity Analyst's Way It’s All About Location See the World (Differently) The Return of the Global Flexible Investor Map of International Value Sound as a Loonie? Fair Exchange In Their Own Worlds A Good Read Putting Their Heads Together Buying Protection Scoping Out Easy-to-Use Funds Finding Good Stewards Consumer Firms Go Global Mutual Fund Analyst Picks Undervalued Stocks Most Popular Variable Annuities New at Morningstar The Whole Wide World

Morningstar Advisor - Fall 2007

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