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Battening Down the Hatches

Captains of Clipper Fund Prepare for a Downturn

May 20, 1997

The skippers of the Beverly Hills-based Clipper Fund see rough sailing ahead for the stock market.

Portfolio managers James Gipson and Michael Sandler have guided Clipper to one of the best track records in the mutual fund business: Their $580-million-asset fund's 271% return for the 10 years ended March 31 far exceeds the 195% return of the average general U.S. stock fund, according to Lipper Analytical Services.

But both men strongly believe that most stocks now are fairly valued or overvalued. Hard-pressed to find appealing issues, they are keeping nearly a third of the fund's assets in cash.

Gipson and Sandler, who have worked together since 1984 (when Gipson founded his investment firm, Pacific Financial Research), were interviewed by Russ Wiles, a mutual funds columnist for The Times.

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Times: Mr. Gipson, you started investing at a very young age, and that is said to be an interesting story in its own right.

Gipson: I was 15 years old. I won $2,100 on a [TV game] show called "The Big Game." That was during the days of the quiz show scandals, but I might add that the show on which I appeared was conducted honestly. I was living in Burbank, near the NBC studios. I just went over to see a show in person one day, and they asked if anyone was interested in trying out.

How I wound up investing my winnings is a sad story, actually. I wanted to buy stock in IBM and DuPont. But being a minor, I couldn't do it myself. So my mother went to a lawyer, who went to a stockbroker, who said those stocks would be much too speculative for young James. So he put me into a load mutual fund, which, by the time I needed the money for college, had simply recouped the load and nothing more.

In the meantime, those were the glory days for IBM and DuPont. In fairness to the facts, however, I knew nothing about security analysis at that point. I just wanted to invest in two stocks that eventually soared, [and] my mutual fund did not.

Times: Mr. Sandler, you started out as a lawyer?

Sandler: I earned a law degree and an MBA from the University of Iowa. But I definitely had more fun picking stocks than studying law. After graduation, I worked for some businesses, including International Harvester, where I helped to liquidate part of the company. One of the lessons I learned is that "book" value [a company's theoretical net liquidation value] has little real relevance. It's an accounting fiction.

We were selling off the construction equipment business at Harvester, and we basically received 20% of the book value. That seems pretty cheap, but Dresser Industries, the buyer, lost money [on the business] every year after purchasing it. So that was a great lesson that book value is meaningless in most scenarios.

Times: The Clipper Fund's performance over the last decade owes a lot to a relatively small number of stocks, because your strategy has been to run a very concentrated portfolio--just 19 stocks are in the fund currently. Can you elaborate on the strategy?

Sandler: The way we add value over the long term is pretty simple: We concentrate on our best ideas. The only way you can feel comfortable doing that is by doing your homework on these companies.

Times: And generally, you also have stuck with shares of large, well-known companies?

Sandler: Yes, for the simple reason that larger companies historically have had better franchises.

What does a good global franchise mean? It means you can spend a lot of money on advertising and marketing, but when you look at the cost per unit sold, it's often lower than [that of] your competitors. So you have this built-in profit margin advantage.

The companies in our portfolio generally dominate their markets, whether domestic or global.

Times: Can you give a few examples from among the fund's holdings?

Sandler: Two stocks that dominate their markets domestically are Fannie Mae [the Federal National Mortgage Assn.] and Freddie Mac [the Federal Home Loan Mortgage Corp.].

They have defined and refined the whole mortgage-guarantee business. They've created a very efficient market [for mortgages], which, in turn, has lowered homeowner costs. They clearly dominate the lending business for conventional loans.

McDonald's is [another] one. It's true the company's domestic business has slowed, but they have much more potential internationally. No other fast-food franchise can hold a candle to them outside of the U.S. McDonald's has broken into Russia with quality products. McDonald's has been the only [fast-food company] able to execute that strategy there. They already enjoy economies of scale [in Russia], so the others have to play catch-up.

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