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'Focused' Value Funds Hot With Investors

Markets: Portfolios of 'best ideas' in bargain stocks boast strong returns--and more risk.


When a strategy works on Wall Street, investors tend to want it in concentrated doses.

That's happening now with "value" stock mutual funds: As value stocks continue to lead the market, funds that offer a focused value approach--meaning a portfolio of a relative handful of shares--are particularly hot with investors.

A focused portfolio approach can make sense for aggressive investors, analysts say. But just as with the focused "growth" stock funds that were the rage in the late-'90s, concentrated funds of any kind carry extra risk.

For now, many investors are tantalized by the performance of focused value funds.

Veteran value manager William Nygren's Oakmark Select fund, which holds only about 20 stocks and is up 11.1% year-to-date and nearly 33% in the last 12 months, has been one of the best-selling equity funds this year, according to Financial Research Corp.

Nicholas Gerber's Ameristock Focused Value, launched Jan. 1, rocketed 31% in its debut quarter.

Many other focused value funds have posted only minor losses so far this year--while the blue chip Standard & Poor's 500 index has fallen more than 10%.

Several giant financial firms, including Prudential Investments and Massachusetts Mutual Life Insurance, say they plan to launch focused value funds later this year.

Value funds, of course, typically invest in stocks with low price-to-earnings or low price-to-book ratios--in other words, shares that are relative bargains, by those measures, versus the broad market.

Growth funds, in contrast, tend to buy stocks of fast-growing companies whose shares usually carry much higher valuations.

Over the last year, the crash of technology shares has hammered growth-oriented funds. At the same time, fearful investors have flocked back to value shares.

Now, "The fact that Nygren and some of the others have done so well is catching people's eyes, just as two years ago Scott Schoelzel [at Janus Twenty fund] and Jim McCall [then at PBHG Large Cap 20] were shooting the lights out with focused growth funds," said Russ Kinnel, head of fund research at Morningstar Inc.

"But the focused-value thing makes sense for other reasons, too," Kinnel said. "Several years ago, investors had one or two funds, but now they may have five to 15 and not much need for more diversification" in their overall portfolio.

Though a few focused-value funds, such as Clipper, Longleaf Partners and Sequoia, have been around for decades, the majority have been launched in the last five years or so, according to Morningstar. There is no official definition of focused value, but Morningstar says there are about 50 value funds that own 40 or fewer stocks and have at least $20 million in assets.

The average diversified stock fund, by contrast, owns more than 100 stocks.

The idea with any type of focused fund is that you're getting only the manager's best ideas.

"This is the fund I would have started five years ago if anybody knew who I was," said Gerber, whose flagship fund, Ameristock, has beaten 99% of its large-cap value peers over the last five years.

In a novel move, he hopes to close the new fund when it reaches $100 million to $200 million in assets, and turn it into a publicly traded company, if shareholders approve. "Rather than trade at net asset value [per share], we could trade at a premium to the net asset value, or book value, as most companies do," he said. He would convert it into a corporation rather than a closed-end fund.

Fund managers and industry analysts say focused portfolios can maximize the talents of a smart stock picker. "If a fund has 100 or 200 names, that tells us the manager doesn't have a whole lot of conviction," said Bruce Veaco, who runs the Clipper and UAM Clipper Focus funds with co-managers James Gipson and Michael Sandler at the funds' Beverly Hills-based advisor, Pacific Financial Research.

"We're not market timers or master economists," Nygren said. The Oakmark Select fund "highlights our greatest ability: stock selection."

As Kinnel put it, "If you're buying active managers, don't you want them to make some sizable bets?"

But a lot of stocks are cheap for good reason, so the key to running a successful value fund is finding those being punished unfairly, managers say.

Ameristock Focused Value's top holding, tire retailer TBC Corp.--which accounted for 22% of the portfolio at the end of the first quarter--had been "doubly punished," Gerber said, for being in two unpopular areas: retail and auto supplies. But as bargain hunters have found the stock, it's up 30% this year.

Gerber also bought retailer Restoration Hardware at about $1 a share, then quickly sold it at nearly $5 when it accounted for about 15% of assets.

"We went to the stores and counted the cash register lines for a month," Gerber said. "We looked at how many pedestrians were going inside, versus the Williams-Sonoma store next door. Restoration's stock was priced like the company was going out of business, but it wasn't."

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