Morningstar Advisor - Fall 2008 - (Page 55)

In his light-filled office near the San Francisco waterside, Presidio Fund PRSDX manager Kevin O’Boyle displays a handwritten 2001 letter from a prospective investor who had heard of O’Boyle through a friend he uncharitably characterized as a “dim light bulb.” Fortunately, the investor concluded that O’Boyle’s bulb burned much brighter, and he cut a check to Meridian Value MVALX, the fund that O’Boyle led before striking out on his own in 2005. A Bright Start O’Boyle certainly is no dim bulb. During his June 1995 to December 2003 stint at Meridian Value, the fund returned 22% per year, more than twice the gain posted by the Morningstar U.S. Market Index over the period and nearly 9 percentage points better than the small-blend category average, the group in which the fund resided during most of that stretch. Presidio, which recently celebrated its third birthday, has also been a success. Through August 2008, the fund was up 8% annually over the trailing three years, versus 3% for the typical small-blend offering. Yet despite this success, Presidio remains relatively unknown, with a skimpy $67 million in assets. O’Boyle’s City-by-the-Bay digs reflect Presidio’s diminutive size; they are no larger than a one-bedroom apartment and could very well have been one in an earlier life. The office, located in the gentrifying Marina neighborhood, is more than a 30-minute walk from the city’s financial district, home to giant firms such as Charles Schwab and Dodge & Cox. The out-of-the-way locale allows O’Boyle to avoid pricey rents, but it also means that he doesn’t hobnob much with other money managers around town. That’s a feeling he’s probably gotten used to. Scoping out potential investments at industry conferences, O’Boyle finds that the companies he’s researching are the ones whose representatives are presenting to sparsely filled rooms. No, O’Boyle isn’t antisocial. His investment process draws him away from companies getting all the attention. While many investors consider failing to meet or beat Wall Street analysts’ earnings expectations for a quarter or two to be a cardinal sin, O’Boyle looks for firms that have suffered at least three consecutive quarters of earnings disappointments. His approach seems counterintuitive at first blush—why would you want to invest in struggling companies?—but it’s designed to take advantage of investors’ tendency to overreact to bad news and incorrectly extrapolate the recent past into the future. By owning stocks that have been punished too harshly for their troubles and where expectations are too modest, the fund can reap outsized gains. The crux of O’Boyle’s strategy was developed by Rick Aster, the founder and comanager of Meridian Value. Aster noticed that companies often rebounded sharply after a spate of disappointing earnings. He had O’Boyle, who had joined his firm as an analyst in 1994, test the idea further using historical market data. Back tests suggested that the strategy of buying disappointing companies and holding them as they rebound could be successful, but both Aster and O’Boyle thought that they could increase their odds of success with research and by concentrating their best ideas. In mid-1995, Aster added O’Boyle as a comanager, responsible for day-to-day stock-picking. This isn’t a strategy O’Boyle was necessarily born to practice. Unlike many money managers who tell you they were checking the stock tables before the sports pages as kids, O’Boyle didn’t get the investing bug until college. Studying economics as an undergraduate at Stanford University sparked his interest, and getting his MBA (also at Stanford) deepened it. His father, a civil engineer by training, charted stock prices, but Warren Buffett’s Berkshire Hathaway shareholder letters had more formative influence. (O’Boyle has read all of them.) O’Boyle’s office shelf is filled with books about the Oracle of Omaha, in addition to another legendary value investor, John Neff, the former manager of Vanguard Windsor VWNDX. You might think that he’s got the reading habits of a dyed-in-the-wool value investor, but O’Boyle also cites Common Stocks and Uncommon Profits—perhaps the bible of growth investing—as having a big effect on his thinking, too. This is the sort of reading list you’d expect from an investor who’s built his career buying beaten-down growth stocks. Aster, however, has left the biggest mark on O’Boyle. A successful investor himself, he taught O’Boyle to focus on the economics underlying companies’ business models. “How does a company earn an attractive return on its businesses?” and “Is it sustainable?” were the key questions on which Aster focused, O’Boyle says. His Own Man O’Boyle hasn’t departed much from the strategy that he employed at Meridian, though he’s used his experience to introduce some tweaks. For example, he more consciously avoids companies in declining industries because he’s found that it’s tough for even good management teams to turn a business around in adverse environments. Still, O’Boyle isn’t dogmatic. Weyerhaeuser WY, a recent addition to Presidio’s portfolio, has suffered amid a weak environment for paper products. But O’Boyle argues that investors have undervalued its timberlands and other business lines, and he points out that the company is divesting its nonstrategic paper and container board units. Although O’Boyle doesn’t make bold top-down calls, he lets macroeconomic factors influence his thinking to a greater extent than at Meridian. Dozens of banks meet his down-three-quarters criteria, for example, but the credit crunch and the tanking housing market has kept him away. (That said, he’s compiling a list of potential picks so he can pounce when housing prices stabilize.) MorningstarAdvisor.com 55 http://www.MorningstarAdvisor.com

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Morningstar Advisor - Fall 2008 Contents New on MorningstarAdvisor.com Letter from the Editor Contributors Inbox Are You Preparing for Higher Taxes? State of Financials Oracles of Alabama Investment Briefs Managers’ Investment Secrets Revealed Conformity Becomes a Growing Concern at American Gimme Shelter Location, Location, Location Rooted in Buffett, Going for Growth Keeping Little Company Away from the Numbers Consumer Confidence What about Natural Gas? TIPS to Beat Back Inflation Investing in Hidden Assets Funds That Have an Edge Come Tax Time Mutual Fund Analyst Picks 50 Most Popular Equity ETFs Undervalued Stocks Most Popular Variable Annuities New at Morningstar One for You, 19 for Me

Morningstar Advisor - Fall 2008

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