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Ralph Shive, 1st Source

Ralph Shive doesn't care about style boxes, relative performance, or Wall Street. He just wants to make money for his clients.

Christine Benz, 06/16/2008

There are the outward trappings of the Corn Belt, of course. Ralph Shive and the 1st Source funds team work in South Bend, Ind., a sleepy town in the northernmost part of the state best known for being right next to the University of Notre Dame. The office is a small and close-knit operation, occupying the first floor of the 1st Source Bank building in downtown South Bend. Over a hearty lunch at a café a few steps from the office, the team joshes with our server. "She used to babysit for my son," says Mike Shinnick, who runs the team's long-short fund.

Shive, the firm's chief investment officer and manager of its flagship fund, 1st Source Monogram Income Equity FMIEX, is plainspoken and direct; his flat speech pattern hints at his Illinois roots. Shive speaks with the air of someone who doesn't worry about impressing Wall Street consultants and who doesn't have to answer to in-house marketers. "I don't care about relative performance. I don't care about style boxes," he says. "My philosophy is, 'Let's do something intelligent with the money.' "

Given Shive's blunt talk and disdain for Wall Street, it's no surprise that he's spent his career elsewhere. He started out at a small trust firm in 1975, then joined InterFirst Bank as a technology analyst a few years after that. Shive worked briefly as a sell-side analyst for Rauscher Pierce Refsnes before moving to a family office in Dallas, where he ran money from 1984 to 1989. Shive still counts that experience as the most formative of his investing life. "Great people, great long-term focus, pure investments, no distractions," he says. "I also learned to embrace that idea that risk is losing money."

Up until then, however, Shive did not have an independent public track record, and that's what brought him to 1st Source in 1989. He ran a common trust initially, then the Income Equity mutual fund, which launched in October 1996.

Since that launch, Shive has amassed a performance record to crow about: The fund has trounced its large- and mid-cap value counterparts as well as the S&P 500. The fund's track record also speaks to Shive's focus on absolute rather than relative returns. During the 2000-2002 bear market, its losses were mild, even though the fund also managed to keep pace during the great bull market of the 1990s.

"We've evaluated Ralph's performance over many time periods and he has consistently stood out relative to other managers we've used," says A.J. Paul, an Elkhart, Ind., financial advisor who manages assets for high-net-worth clients. "He makes money in up markets but often loses less when things are going down. In 2008, no one is having a stellar year so far, but he's lost less than everyone else."PAGEBREAK

Don't Box Him In
Shive's approach to managing client assets is very much in keeping with his sensible, no-nonsense personality--and also speaks to his unwillingness to be pigeonholed. His investment style is distinctly value-oriented, but not dogmatically so; the fund's holdings are dispersed across the upper two thirds of the Morningstar Style Box. That's because Shive is emphatic about preserving the fund's flexibility and makes room for what he calls "franchise value" stocks--essentially GARP names--alongside traditional value fare. While industrials have long played a big role in the portfolio, he has given the fund more of a growth tilt over the past year or so.

"The objective is making money, and I maneuver around a little bit," he says. Zimmer Holdings ZMH, the maker of artificial joints, was one such recent addition. The stock lands in the large-growth square of the style box, but Shive thinks it's a great company that was recently trading at a below-market multiple.

Shive also works hard to avoid so-called value traps--statistically cheap stocks that grow cheaper still--by considering the quality and positioning of the underlying business as well as the current point in the economic cycle. The fund's recent stance within the financials sector exemplifies his willingness to act boldly if he thinks a sector's troubles overwhelm stocks' merits on a bottom-up basis. As the drumbeat of bad news regarding the housing market grew louder in 2006 and into 2007, Shive foresaw the spillover effects for financials stocks, and he reduced the fund's exposure to the sector. He took the portfolio's weighting down near the single digits--a dramatic bet for a fund in the large-value group, where the sector is most funds' biggest weighting. As a result of that reduced exposure, the fund came through last year in fine form, dodging banks' big losses and scoring big gains from its energy and industrials holdings.

Shive is not inclined to jump back into financials with both feet anytime soon, either. "If you just think they're cheap and they've got a big yield, and you're going to buy them without putting it in context of the macro picture of what's wrong, well, that macro piece has been the critical variable," he says. Shive also pays attention to mutual fund cash flows. He is concerned that managers of some large-value-oriented funds will be forced to sell holdings to meet shareholder redemptions. He thinks such outflows would weigh on financials for some time to come. (For that matter, he's concerned that outflows from value funds could affect a host of value stocks, not just financials.)PAGEBREAK

A Long Reading List
To help stay abreast of secular trends and keep minutiae from overwhelming a head wind or tail wind facing a company or an entire industry, Shive reads voraciously. During the course of our interview, he pulls numerous books off his shelves and cites nuggets of insight. Every day, he reads a number of periodicals; he considers China Daily a must-read, for example. He and the team also prize Williams Inference, a service that culls readings from disparate sources around key themes--anything from teenagers' social patterns to growth in emerging markets to the latest fashion trends. "It's like sifting for gold," Shive says of his information-gathering process. "You pan piles of rock and stuff to look for a few nuggets that you want to take action on."

All that reading occasionally adds up to a flash of insight that prompts Shive to make big changes to the portfolio, such as the shift out of financials. Although Shive trades infrequently--turnover has averaged roughly 25% for most of the fund's life--he says his trading tends to come in fits and starts.

Shive also periodically keeps cash on hand, so he can protect capital during rocky markets and pounce on opportunities as they arise. Cash ranged into the double digits in 2001 and 2002, for example, and the fund had a 14% cash stake as of its most recently available portfolio. "With questions about whether we're heading into recession, and problems with housing and the consumer, I want to have some dry powder," he says. "I think that I'll be able to buy some stocks cheaper."

Not Like the Others
If all of this makes the fund sound like the most unlikely sort of bank-run offering, that's exactly the point. Bank mutual funds are notoriously buttoned-down, often targeting fully invested, style-specific portfolios and returns that land in a category's middle two quartiles. By contrast, Shive's flexible, nimble approach and goal of delivering all-weather performance are a breath of fresh air.

"He's certainly not your typical highly conservative bank manager," concurs Paul, the Indiana advisor. "He's what I'd call 'reasonably aggressive,' meaning that he's aggressive about making money and also aggressive about preserving it."

But the fund does share at least a few things in common with other bank-run offerings--notably, a fairly lean staff. Shinnick, who has amassed a solid track record at 1st Source Monogram Long/Short Fund FMLSX, works closely with Shive, and the pair employ two equity analysts. Shive and Shinnick also rely on outside research firms--including William O'Neil, Leuthold, and Ned Davis--to supplement their own work. Shive argues that employing more people would push him to trade more than he cares to. "If you have a stable of analysts, they're chomping on the bit, 'I want my idea in the portfolio. I've got to do something.' Western culture is all about action, right? But often the best course of action is doing nothing."PAGEBREAK

If Shive is concerned about anything these days, it's how the portfolio's heavy weighting in the industrials sector might be affected by an economic downturn. He mentions it several times in the course of our day together. Holdings such as Raytheon RTN and Alcoa AA have enjoyed a big runup over the past several years, and Shive is concerned about overstaying his welcome.

Another consideration for investors looking at the fund right now is how it would fare if mid-caps and smaller large caps, which figure prominently in the portfolio, ceded market favor to mega-caps for an extended period of time. Shive has gradually shifted more and more of the portfolio into blue chips as he has seen values emerge, but the fund has spent much of its life in Morningstar's mid-cap value category and retains its share of off-the-beaten-path names. The fund's market cap is notably smaller than the typical large-value fund's. "I am worried about my style," he admits, "And I'm trying to ameliorate the risk there. I'm thankful I'm at a firm where I'm allowed to float around a little bit."

That candor is refreshing, as is Shive's disdain for complacency and conventional wisdom. The fund might not always look quite as terrific as it does today, but we think it's a good bet that advisors and their clients can trust Shive to do, as he puts it, something intelligent with their money.

Christine Benz recently became Morningstar's director of personal finance and editor of the Morningstar Practical Finance newsletter after serving as director of fund analysis for two years.

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