With a rock-solid belief in their strategy, the managers of Homestead Value confidently go about their business.
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The economic crisis hasn't shaken the foundation of Homestead Value Fund
Indeed, the fund's longtime managers have been calmly conducting business as usual. The fund had no exposure to large-cap value disaster American International Group
"Although we make sure to maintain an open curiosity [about new investments], sometimes it's best to let things just percolate along," says Ashton, who came to Homestead Funds from Capital Research and Management in 1999. Indeed, the team's picks sometimes require patience. The team's investment process is "the exact opposite of that used by relative-strength or trend followers," says Peter Morris, who has run the fund with Stuart Teach since its 1990 inception. "Often, when we buy a stock, its relative strength is negative." The managers move deliberately, generally building positions slowly and selling gradually.
The team also plays confidently. This is a concentrated portfolio, with 45 holdings as of the end of 2008, and almost no cash. The managers may seek out companies in trouble, but they require sound balance sheets, healthy cash flow, and demonstrated strength in particular areas of business--and reason to anticipate a turnaround, such as a change in leadership. That fosters the possibility that "others might recognize the value for us," Ashton says, and acquire the company. Former holdings Wendy's International and IKON Office Solutions were bought out in 2008.
The idiosyncratic portfolio has a hardware stake nearly three times the large-cap value average. Hewlett-Packard HPQ, Dell
Dell, Intel, and Cisco were added as value opportunities arose in 2006 and 2007. Intel, for example, was under pressure from competitor Advanced Micro Devices
Ashton expects that these are investments for the long haul, as an improving economy expands the market for the companies' ever-advancing technologies. "One thing I've learned here is that not being in a hurry can yield benefits," Ashton says. "A traditional value shop would have let Hewlett-Packard go earlier in the story, but there is more to come. The acquisition of [IT service provider] EDS opens lots of doors."
At year-end, the fund was dominated by a 26% stake in health care, primarily pharmaceuticals, which fared relatively well in 2008. Morris says the companies' high dividend yields and strong balance sheets more than compensate for concerns such as patent expirations and increasing government regulations. Abbott Laboratories
In the more traditional value arena, the fund had 13% financials at year-end, which is significant but less than three fourths of the typical large-cap value stake.
"The current environment caused us to do something we don't normally do: sell stocks when they are down," Morris says. "Anyone who owns financials has had to average down." The managers made a timely sale of Washington Mutual WAMUQ in late 2007, because the bank was overconcentrated in aggressively packaged mortgages. "We sold in the midteens, so we fared well," Morris says. Over the past year, the managers also cleared out of Citigroup
"We decided which financials had the wherewithal to withstand the buffeting of the economy in general," Ashton says. Keepers include the well-capitalized J.P. Morgan
The fund's largest insurance holding is Chubb Corp.
The portfolio is further distinguished by a large stake in mid-cap names, roughly one third of assets. The fund's $350 million asset base allows it to take advantage of names such as top-10 holding Parker Hannifin
Other lesser-known names also seem tailor-made for the management team's long-term strategy. Defense contractor SAIC
The fund's investment in small-cap Office Depot
Created for a Rural Coop
Despite the occasional misstep, this concentrated, low-cash portfolio has held up reasonably well in the current bear market (as it did from 2000 to 2002). It placed in the top half of the large-cap value category in 2008 and in the top third for the 12-month period through March 2009. Over the long term is where the fund has earned its stars, though: Through the five- and 10-year periods through March, it places in the top quartile of its category.
Better yet, when taxes are taken into the account, the fund's long-term category rankings rise to the top 20%. Morris notes that all the managers have significant stakes in the fund and are well aware of the tax consequences of active trading.
The fund has yet one more advantage, one that ensures it an edge over its peers in any market: a tiny 70-basis-point expense ratio. That is less than half the large-cap value norm--even though the fund's asset base is also well-below average. It is unusual for such a small fund company that doesn't enjoy the economies of scale of a Vanguard or a T. Rowe Price to keep shareholder costs so low.
All this raises the question of why a fund with a 15-year history of excellence under the same management team has not drawn more attention. "They are unknown because they aren't spending client money on wholesale marketing or advertising or fancy conference calls," says Dan Henken, a senior investment consultant who provides research for advisors associated with St. Paul, Minn.-based Securian Financial Group. "They don't come with all the pageantry." In fact, Homestead Funds was created in 1990 as an affordable investment resource for members of the nonprofit National Rural Electric Cooperative Association, and most of the company's assets still stem from that source.
Not a Pure Play
The fund does come with a caveat or two. The first is the above-average volatility that accompanies a concentrated, buy-and-hold portfolio with minimal cash. Henken says that his research team's quantitative screens allow managers to take active risk provided it is accompanied by outperformance. He frames the volatility within the perspective of the fund's low-turnover track record of sensible stock picks: "The managers see themselves as a fiduciary for NRECA and they are unlikely to take wild risks," he says.
The fund has not yet paid off for those who bought in on Henken's recommendation in January 2008, but he is unshaken: "It was a good move; we are happy and still confident in them."
Investors who can still stomach stocks may not be put off by some extra volatility, but someone looking to neatly fill the large-cap value segment of the style box might consider this portfolio insufficient. Not only is it concentrated and quirky, but it has less than 30% of its assets in pure large-value stocks, and its average market cap of $19 billion is on the small side for its category.
Advisor Jim Quandt, a senior partner with Fortune Financial in Minneapolis, Minn., believes that the fund's "low expenses, low turnover, and experienced management make it an exceptional find in this category." However, he considers the fund "a very nice complement to a more traditional large-value fund."
That said, management's long-term results make this a suitable core holding for any investor willing to take on equity risk. The fund is certainly a boon for NRECA members and for those without much money to invest upfront--but it deserves to be known as more than just a niche product.
Laura Lallos, a former Morningstar analyst and editor, is a frequent contributor to the magazine.
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