Morningstar Magazine - February/March 2014 - (Page 69)

that could extract additional commodities given advances in drilling technology. Dawson has little debt and plenty of cash and saw its share price jump 25% in 2013. While those two sectors have provided tailwinds for the fund lately, a lack of health care countered some of those gains in 2013 as the sector was one of the best performers in the Russell 2000 Index. Lenhoff has largely avoided unproven biotech firms, despite the big gains some of these firms can post. He's also wary of the impact of the Affordable Care Act on the sector, which caused him to sell a position in plan provider Centene CNC in December. Lenhoff, though, has begun slowly buying it again as clarity has formed around the impact of a new tax and the firm's ability to pass higher costs along to customers. Healthcare exposure has typically been around 10% during Lenhoff's tenure. Lenhoff, doesn't mind seemingly being out of step with an index or his rivals. Indeed, he bought Gildan Activewear GIL in early 2012 as the t-shirt company's shares dropped over concerns about higher cotton prices. He liked the firm's low-cost manufacturing operations in Honduras, the potential for new contracts with U.S. clothiers, and a growing sock business. As cotton prices have come back down on lower demand from China, the shares have more than tripled. "They didn't increase prices" when cotton prices rose, he says, even though rivals did. "They used price to win customers." The fund has been volatile at times, and Lenhoff tends to trade more often than his peers, as evidenced by a 97% turnover ratio (versus 63% for the peer group average). But the fund has a low Morningstar Fee Level, surprising for an offering of its size. In addition, Lenhoff and team have generated a 16.7% annualized return the past three years through Jan. 15, 2014, exceeding the Russell 2000 Index and its small-blend peer group by 2.2 and 2.7 percentage points, respectively. Tucked Away in the Keystone State One of the positive attributes of some bank-run funds is that they have grown out of trust departments (or leaned on them for assets). That relationship usually translated into a strategy where downside protection was key. That is the case with Stewart Capital Mid Cap SCMFX, which is part of Pennsylvania20000 based S&T Bank. Since its 2006 inception, the fund has captured just 85% of the market's losses, considerably lower than the average peer. Its 34.3% loss in 2008,12000 painful on while an absolute basis, was almost five percentage points better than the average mid-blend 4000 fund. "It's nice to make money on the way up," says the fund's comanager Malcolm Polley. "It's even nicer to keep it on the way down." Polley's stock-picking process is conducted with the help of a team of comanagers and analysts and begins with a top down view, not only on macroeconomic factors but also themes that could benefit certain sectors and stocks as they play out. To identify those potential beneficiaries, he looks for well-run companies with high returns on capital and good growth prospects whose shares are typically trading around a 15% to 20% discount to his assessment of their fair value. He frowns on buying stocks that may have just a tangential exposure to a given theme. For example, in 2008 Polley developed a theme around agriculture, an industry he thought would benefit from the improved diets of rising emerging-markets middle classes. To play that, he looked at companies such as Caterpillar CAT, but he didn't like that the company was also beholden to the construction industry that was tanking. Instead, he bought or added to fertilizer stocks such as Chile-based SQM SQM and CF Industries CF, which helped his fund post a 46% return in 2009. Those purchases came after Polley had built up a large cash heading into the downturn. "We got out of everything with mortgage exposure," he says. "We couldn't really find anything that excited us enough to recycle the money." The fertilizer bet was one of his first big moves once he thought the worst was over. Malcolm Polley Stewart Capital Mid Cap SCMFX $20K 12 S&P MidCap 400 TR 01/ 07 01/ 09 Category 1/07 1/08 Mid-Cap Blend 1/09 01/ 11 1/10 01/ 13 Expense Ratio (%) 1/11 1/12 1/13 1.5 Morningstar Rating QQQ 5-Yr Annl Total Rtn (%) 21.98 Minimum Investment $1,000 5-Yr Total Rtn % Rank Cat 24 Data as of Dec. 31, 2013 But there is a downside to this strategy, depending on how you look at it. The fund gained a respectable 25.7% in 2013, which trailed most peers as the average mid blend fund gained almost nine percentage points more. An overweight to basic materials hurt as stocks such as Southern Copper SCCO dropped 38% on concerns about slowing global economic growth. The fund typically lags peers in such rallies. Polley, though, is comfortable occasionally bringing up the rear of the pack in such a charged market. That is the price you pay for downside protection, he says. The merits of his strategy may be apparent soon if corporate earnings slow in 2014, leading to a market pullback. "The economy could continue to muddle through," Polley says. If that is the case, the fund's appeal would likely grow. K Rob Wherry is the associate editor of Morningstar magazine. global.morningstar.com/Morningstarmagazine 69 http://global.morningstar.com/Morningstarmagazine

Table of Contents for the Digital Edition of Morningstar Magazine - February/March 2014

Morningstar Magazine - February/March 2014
Contents
Contributors
Letter From the Editor
Preparing for the Next 50 Years
Morningstar Managers of the Year
Fixing the Trust Deficit
Rethinking the Path to Retirement
Trends
Same Old, Same Old
Global Briefs
The Economic Implications of an Older World
Banking on Performance
Is the Affordable Care Act Healing Health Care’s Woes?70
Baxter Has a Positive Prognosis
Leading Fidelity’s Charge for RIAs
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
Moving the Goal Post

Morningstar Magazine - February/March 2014