Morningstar Advisor - October/November 2010 - 48

Undiscovered Manager

Why doesn’t Kent Croft have billions of dollars in the fund? Because nobody has heard of it.
Adam Bold, founder of The Mutual Fund Store

Overall, though, the mutual fund has the hallmarks of a value portfolio. The average forward P/E ratio as of Aug. 16 was slightly lower than the broad market. The companies have relatively low debt/capital ratios and plenty of cash to pay off any burdens (as measured by interest coverage ratios). The portfolio’s average dividend yield is 2.2%.
Patience Is (Sometimes) a Virtue

exploration and production firm. Petrobank has gone through a remarkable transformation the past decade thanks to both organic growth and acquisitions. Revenue and net income jumped to $1.1 billion and $145 million, respectively, in 2009, up from just $46 million and profits of $10 million in 2000. The Crofts originally bought 13,000 shares of Petrobank for the Value fund in the second quarter of 2005 for about $4.50 apiece. A cheap price tag wasn’t the only reason the managers liked the stock. They also liked the macro themes of worldwide oil demand and Canada being second only to Saudi Arabia in terms of reserves. The company had sizable holdings in that country’s oil sands and in fields in Colombia and Peru. Petrobank also had a proprietary, potentially environmentally friendly drilling technique that reduced the viscosity of trapped oil, making it easier to pump out of the ground. The Crofts think Petrobank’s Canadian and South American production subsidiaries alone support the $38 price tag as of Sept. 3. That doesn’t include the oil-sands reserves or the technology. Croft Value now owns almost 250,000 shares. One big bet that hasn’t worked out yet is Weyerhaeuser WY. Management has streamlined this one-time paper and pulp giant, shedding assets and using the proceeds to pay down debt. What is left is about 6 million acres of timberland and a company whose fortunes are tied to the housing market. The Crofts started buying the stock in 2006, when the shares were around $60. Then, the downturn hit. The stock dipped below $20 in early 2009. The Crofts, however, have stuck with it—even

adding more than 300,000 shares recently and inserting the bonds in Croft Income. They think the firm’s recent conversion into a REIT will jump-start the shares like it did for similar competitors, and they are willing to wait out a rebound in housing.
Can They Keep It Going?

Conviction in their stock picks has both helped the Crofts and, at times, hindered their performance. Historical returns are telling: When the market bottoms, Croft Value tends to hit even harder because the managers stand by their picks— turnover is just 11%. During the late 1990s, the global currency crisis dinged Croft Value’s natural-resources stocks, leading to a 25% loss in the third quarter of 1998. During this past decade, the fund dropped by 26% in the 2002 bear market, 4 percentage points behind the broad market, and in 2008 it suffered an 18% loss in the third quarter and a 25% loss in the fourth quarter, far worse than the S&P 500’s declines. Each time, though, the fund has come back. The fund was in the middle of the pack in the wake of the tech bust, then landed in the top decile of its peer group for three straight years starting in 2005. Last year, it gained 38%, 10 points ahead of the category average. “This is a deep-value fund. People have to be patient,” Bold says. “There are going to be months or quarters when it takes the market longer to see the value the [managers at Croft] did.” One stock that encapsulates that thinking is Petrobank, the Canadian oil and natural gas

For the year to date, Croft Value is down 0.2% through Sept. 3, a shabby showing on an absolute basis, but more than a percentage point ahead of the competition. The portfolio looks cheap, with an average forward P/E of 13 versus 15 for the S&P 500, while the estimated long-term earnings growth rate is 12%, 2 percentage points more than the broad market. That said, if Croft Value wants to stay in the top quartile of its peer group it will be on the back of industrial-material firms like Weyerhaeuser. The fund’s weighting in that sector is 3 times that of the benchmark index. The team at Croft will have some other obstacles with which to contend. As Croft Value’s profile has risen the past few years, so, too, have fund flows. Assets have jumped to $310 million from $12 million four years ago. The firm has lowered expenses to 1.32%, down from around 1.5% a year ago. That is still a bit high, especially considering the huge inflows. (There is no formal schedule to reduce fees if assets hit certain levels.) In addition, the Croft sons will have the chore of passing along the wisdom doled out by their father as they take on more day-to-day responsibilities. At least they won’t have to worry about the building they call home. K
Rob Wherry is a mutual fund analyst with Morningstar.

48 Morningstar Advisor October/November 2010



Morningstar Advisor - October/November 2010

Table of Contents for the Digital Edition of Morningstar Advisor - October/November 2010

Morningstar Advisor - October/November 2010
Contents
New on MorningstarAdvisor.com
Contributors
Letter From the Editor
What estate-planning strategies are you and your clients doing before the end of the year?
Next Steps for ETFs
Investment Briefs
Taking It Personal
A Model Practice
Find the Right Fit
Will REITs Put You in the Penthouse?
Prepare for the Worst
Tips for Common Family Situations
Might Makes Right
Built to Last
Four Picks for the Present
Tactical Strategies Miss Their Mark
Time to Hop on the Commodities Bandwagon?
Retailers Balance Caution and Catalysts
In Search of … Recession Survivors
Turmoil-Tested Small-Cap Funds
Mutual Fund Analyst Picks
50 Most Popular ETFs
Undervalued Stocks With Wide Moats
VA Sales Rise in Second Quarter
The Third Rail
Morningstar Advisor - October/November 2010 - Intro
Morningstar Advisor - October/November 2010 - Morningstar Advisor - October/November 2010
Morningstar Advisor - October/November 2010 - Cover2
Morningstar Advisor - October/November 2010 - 1
Morningstar Advisor - October/November 2010 - 2
Morningstar Advisor - October/November 2010 - Contents
Morningstar Advisor - October/November 2010 - 4
Morningstar Advisor - October/November 2010 - 5
Morningstar Advisor - October/November 2010 - New on MorningstarAdvisor.com
Morningstar Advisor - October/November 2010 - 7
Morningstar Advisor - October/November 2010 - Contributors
Morningstar Advisor - October/November 2010 - Letter From the Editor
Morningstar Advisor - October/November 2010 - What estate-planning strategies are you and your clients doing before the end of the year?
Morningstar Advisor - October/November 2010 - 11
Morningstar Advisor - October/November 2010 - Next Steps for ETFs
Morningstar Advisor - October/November 2010 - 13
Morningstar Advisor - October/November 2010 - Investment Briefs
Morningstar Advisor - October/November 2010 - 15
Morningstar Advisor - October/November 2010 - 16
Morningstar Advisor - October/November 2010 - 17
Morningstar Advisor - October/November 2010 - Taking It Personal
Morningstar Advisor - October/November 2010 - 19
Morningstar Advisor - October/November 2010 - A Model Practice
Morningstar Advisor - October/November 2010 - 21
Morningstar Advisor - October/November 2010 - Find the Right Fit
Morningstar Advisor - October/November 2010 - 23
Morningstar Advisor - October/November 2010 - 24
Morningstar Advisor - October/November 2010 - 25
Morningstar Advisor - October/November 2010 - Will REITs Put You in the Penthouse?
Morningstar Advisor - October/November 2010 - 27
Morningstar Advisor - October/November 2010 - 28
Morningstar Advisor - October/November 2010 - 29
Morningstar Advisor - October/November 2010 - 30
Morningstar Advisor - October/November 2010 - 31
Morningstar Advisor - October/November 2010 - Prepare for the Worst
Morningstar Advisor - October/November 2010 - 33
Morningstar Advisor - October/November 2010 - 34
Morningstar Advisor - October/November 2010 - 35
Morningstar Advisor - October/November 2010 - Tips for Common Family Situations
Morningstar Advisor - October/November 2010 - 37
Morningstar Advisor - October/November 2010 - Might Makes Right
Morningstar Advisor - October/November 2010 - 39
Morningstar Advisor - October/November 2010 - 40
Morningstar Advisor - October/November 2010 - 41
Morningstar Advisor - October/November 2010 - 42
Morningstar Advisor - October/November 2010 - 43
Morningstar Advisor - October/November 2010 - 44
Morningstar Advisor - October/November 2010 - 45
Morningstar Advisor - October/November 2010 - Built to Last
Morningstar Advisor - October/November 2010 - 47
Morningstar Advisor - October/November 2010 - 48
Morningstar Advisor - October/November 2010 - 49
Morningstar Advisor - October/November 2010 - Four Picks for the Present
Morningstar Advisor - October/November 2010 - 51
Morningstar Advisor - October/November 2010 - Tactical Strategies Miss Their Mark
Morningstar Advisor - October/November 2010 - 53
Morningstar Advisor - October/November 2010 - 54
Morningstar Advisor - October/November 2010 - 55
Morningstar Advisor - October/November 2010 - 56
Morningstar Advisor - October/November 2010 - 57
Morningstar Advisor - October/November 2010 - Time to Hop on the Commodities Bandwagon?
Morningstar Advisor - October/November 2010 - 59
Morningstar Advisor - October/November 2010 - 60
Morningstar Advisor - October/November 2010 - Retailers Balance Caution and Catalysts
Morningstar Advisor - October/November 2010 - 62
Morningstar Advisor - October/November 2010 - 63
Morningstar Advisor - October/November 2010 - 64
Morningstar Advisor - October/November 2010 - 65
Morningstar Advisor - October/November 2010 - In Search of … Recession Survivors
Morningstar Advisor - October/November 2010 - 67
Morningstar Advisor - October/November 2010 - Turmoil-Tested Small-Cap Funds
Morningstar Advisor - October/November 2010 - 69
Morningstar Advisor - October/November 2010 - Mutual Fund Analyst Picks
Morningstar Advisor - October/November 2010 - 71
Morningstar Advisor - October/November 2010 - 72
Morningstar Advisor - October/November 2010 - 73
Morningstar Advisor - October/November 2010 - 50 Most Popular ETFs
Morningstar Advisor - October/November 2010 - 75
Morningstar Advisor - October/November 2010 - Undervalued Stocks With Wide Moats
Morningstar Advisor - October/November 2010 - 77
Morningstar Advisor - October/November 2010 - VA Sales Rise in Second Quarter
Morningstar Advisor - October/November 2010 - 79
Morningstar Advisor - October/November 2010 - The Third Rail
Morningstar Advisor - October/November 2010 - Cover3
Morningstar Advisor - October/November 2010 - Cover4
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