Making the Call on Smartphone Winners and Losers

Erik Becker and Gus Zinn are comanagers of Waddell & Reed Core Investment UNCMX and Ivy Core Equity Fund WTRCX. They recently answered our questions on the thematic component to their investment strategy and also discussed how they've positioned their portfolio in response to their convictions of a global economic rebound. Finally, they elaborated on how they evaluate firms for long-term earnings potential and discussed some red flags that could trigger the sale of a holding.

1. Your approach combines top-down themes with bottom-up stock-picking. What are the advantages of this approach versus a strictly bottom-up strategy?
Our primary driver in stock selection is exploiting multiyear earnings catalysts that are underappreciated by the market in companies that have strong or strengthening competitive advantages. Within that, earnings catalysts are diversified across company-specific and thematic projections.

One advantage of this approach is the full utilization of the research capabilities at our disposal. The central aspect of the firmwide research process is a daily roundtable discussion with the majority of our research staff, including equity analysts and fund managers, fixed-income professionals, international analysts and managers, and members of our senior management team.

All information relevant to investment decision-making is discussed. This challenging and collaborative environment leads to superior theme selection and development because ideas are explored from a variety of angles. Linkages are explored, and everyone benefits from and hears the same information. Similarly, company-specific ideas are consistently challenged, which we believe leads to a heightened standard of thinking across the organization.

2. In his recent report on your fund, Morningstar analyst Josh Koeck wrote, "[The fund's] themes are developed in collaboration with other Waddell & Reed managers and analysts." Are you pursuing any themes that are exclusive to this portfolio and not necessarily the result of any collaborative work? If so, what's an example?
Our centralized research process that spans the entire investment organization ensures that each analyst and fund manager has input to and benefits from the overall process. The collaborative approach ensures that individual management teams are aware of dominant themes and growth drivers in the marketplace. At the same time, the process serves to highlight important areas of risk.

For example, our research process was helpful in 2007 and 2008 in ensuring that all the investment professionals here were aware of risks associated with the financial crisis and the knock-on effects across a broad swath of the economy. Each fund management team incorporates aspects of the firmwide process in ways that are consistent with each fund's style and objective. Therefore overlap of dominant themes is relatively common.

Capitalizing on an emerging heavy truck cycle is a theme that has been somewhat unique to the large-cap core product. Beginning in 2009, we began positioning for a rebound in developed-market truck sales by purchasing companies such as Cummins CMI, Paccar PCAR, and Eaton ETN. We were enticed by evidence of an improving economy, knowledge that the existing truck fleet had a finite useful life (due to wear and tear), valuations that did not embed a recovery, and a host of ideas that fit well within our objectives.

3. In late 2010, the fund was homing in on a theme of mobile broadband technology. Is that still an emphasis for the portfolio, and if so, how is it reflected in your holdings? Do you believe other market participants are underestimating the growth potential of this area?
Mobile broadband continues to be a prominent theme within the portfolio. In fact, we believe that we are still relatively early on in the development of the theme. Latest numbers suggest that the global adoption of smartphones is somewhere around the 20% range. Over time, we expect that number to move closer to 80% as technology evolves and becomes more affordable in areas outside of the United States. This shift has massive implications for the food chain, be it service providers, handset manufacturers, chip companies, networking vendors, or companies that supply capital equipment into the chain.