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What Fires Up Mairs & Power

Homegrown stocks and talent drive the Minnesota firm's long-term success.

Daniel Culloton and Josh Koeck, 12/20/2010

This article first appeared in the December 2010/January 2011 issue of Morningstar Advisor magazine. Get your free subscription here.

When Glenn Johnson first interviewed for a job at Mairs & Power, one of the partners at the St. Paul, Minn., investment firm asked whether he minded being a generalist. Not at all, replied Johnson. He'd covered a variety of sectors in 20 years as an analyst and manager in Twin Cities wealth-management outfits.

But that wasn't what Johnson's interrogator meant; he wanted to know whether Johnson would mind painting walls, making coffee, and taking out the trash.

The exchange may have been a joke. But it reveals a lot about Mairs & Power. You don't go there to be a rock-star fund manager. Indeed, though the firm has been around for nearly 80 years and has almost $4 billion under management, its investment profe-ssionals are hardly household names, and they don't want to be. They are there because they share the firm's affinity for frugality, humility, diligence, and patience and its passion for long-term investing and Midwestern stocks, particularly those located near its Minnesota home.

Deliberate and Provincial
Money may never sleep on Wall Street, but 1,200 miles away, in offices overlooking the Mississippi River, Mairs & Power moves at a languid, some might say somnolent, pace. It has launched just two mutual funds since George Mairs Jr. founded the firm in 1931. Portfolio turnover at both Mairs & Power Growth MPGFX and Mairs & Power Balanced MAPOX is lower than some index funds, and personnel turnover isn't much higher. The firm does virtually nothing to promote or market itself, and as recently as 2002, both funds were only available in about two dozen states. (They're nationwide now.) Lots of firms like to compare themselves with the tortoise in Aesop's fabled race, but Mairs & Power makes that turtle look like Usain Bolt, the world-record-holding Jamaican sprinter.

"If you walk around this office, there's no way you can tell if the market is up 30% or if it's down 30%," says Mark Henneman, a Mairs & Power Growth comanager who joined the firm six years ago.

The firm's deliberateness is not the only quality that sets it apart, though. It takes the idea of staying within its circle of competence to, some might say, an extreme. It specializes in stocks headquartered near Minneapolis-St. Paul and the upper Midwest. About two thirds of Mairs & Power Growth's assets are in Minnesota stocks, and three fourths are based in the Midwest. Mairs & Power Balanced ventures farther afield but retains a Midwestern and Minnesota bias.

The pace and provincialism have been good for Mairs & Powers' fund owners. There aren't many funds that have been around as long as the firm's offerings, but the Mairs & Powers funds have been competitive with the best of them. Since their inceptions, the Growth and Balanced funds have posted returns that rival much more heralded contemporaries, such as American Funds Investment Company of America AIVSX and Dodge & Cox Balanced DODBX. From its November 1958 inception through early October 2010, Mairs & Power Growth gained a little more than 11% annualized and would have turned a $10,000 investment into more than $2 million, similar to the returns of Investment Company of America over the same time period. Mairs & Power Balanced fund gained 9.6% annualized and would have grown an initial $10,000 investment to more than $940,000 from its January 1961 birth through early October 2010, which is similar to the performance of Dodge & Cox Balanced. PAGEBREAK

Mairs Heritage
Much of that record belongs to previous generations of managers, notably George Mairs Jr. and his son and successor, George Mairs III. But the funds have been pretty impressive under the subsequent leadership of manager Bill Frels, who joined the firm in July 1992 after a long career at local bank trust departments. The Balanced fund's more than 9% annualized gain since Frels joined is better than nearly 90% of balanced funds. The Growth fund's 7% gain since the July 1999 start of Frels' tenure there through early October 2010 is better than 80% of domestic-stock funds.

Some investors balk at the firm's unusual approach. The home-state bias concerned Harold Kirschner, a Denver-based financial planner, before he investigated the firm for an institutional client. Ultimately, he and his firm, Sharkey, Howes & Javer, realized there was more to Mairs & Power than its loyalty to Minnesota. The planners recommended the Growth fund to their client and began using it in their retail accounts because they liked the fund's conservative, consistent, buy-and-hold philosophy.

Kirschner realized Mairs & Power's leanings were less a gimmick than a natural outgrowth of the firm's process and belief in investing in what it knows best. When George Mairs Jr. started the firm in the Great Depression, he focused on railway stocks. Under his son, who joined the firm in 1952 after stints in the Army and at Macalester College, the firm broadened its menu to the shares of other com-panies in the Twin Cities area that the mana-gers could visit frequently and get to know well.

Mairs & Powers' managers think their edge is getting to know the managements, competitive advantages, and weaknesses of its holdings very well. George Mairs III, who retired in 2004 but remained a presence at the firm until a few months before his death in May, used to lecture CEOs on the strategies of their predecessors' predecessors, Frels says. Even now, the firm's eight managers and ana-lysts spend a long time researching companies' products, markets, business models, and executives before putting them on a short, 15-stock buy list that's updated once a month.

Stingy Growth Strategy
The team members consider themselves stingy growth investors. They are more willing than most to settle for pokier companies that are attractively priced than they are to buy richly valued highfliers. They prefer financially sound businesses with defensible market positions that are capable of delivering steady, above-average returns on equity. The team sets price targets for every stock and gravitates toward those that can appreciate by 20% to 50% over three to five years.

The team cultivates deep familiarity with current and potential holdings and then lies in wait, sometimes for years, for the right opportunity to buy a favored stock. They don't rely on any one valuation metric to decide whether something is cheap--referring to enterprise value/EBITDA in the energy sector, price/sales among technology stocks, and dividend yield with health-care companies.

They'll let some chances slip by--the funds never pulled the trigger on Minnetonka, Minn.-based UnitedHealth Group UNH, for example, because it was never cheap enough for them.

The funds look different from most of their peers. The equity portfolios are fairly compact with fewer than 50 holdings, many of them concentrated in the industrial-materials sector but spread all over the market-cap scale. Widely held blue-chip stocks with wide economic moats, such as Johnson & Johnson JNJ and 3M MMM, rub shoulders with smaller regional firms like landscaping company Toro TTC. Many holdings, such as retailer Target TGT, meatpacker Hormel Foods HRL, and specialty chemical company H.B. Fuller FUL, have been in the portfolio for years, if not decades. In the past 11 years, turnover has rarely risen above 5%.

The firm's analysts and managers aren't under any pressure to generate new ideas, but that doesn't mean they never have them. They keep their eyes open for overlooked stocks. In early 2010, they bought Western Union WU, a mid-cap stock, because they knew the wire-transfer business well from owning other companies in the bank-payments field that had been taken over, such as eFunds and Metavante, and at least one that nearly went under in the financial crisis--MoneyGram International MGI. The fund also revisited medical-supplies-maker Baxter International BAX because it looked cheap, considering its product pipeline.

More stocks from outside Minnesota show up in the funds' portfolios than they did years ago, the managers concede. In addition to New Jersey-based Johnson & Johnson, they own San Francisco-based Wells Fargo WFC and Connecticut-based General Electric GE, for example. Most of these picks, however, have substantial operations around the Twin Cities or once gobbled up a local company. Wells Fargo merged with Norwest more than a decade ago, and the cardiac-rhythm management business of Guidant, which Johnson & Johnson acquired, was based in a Minneapolis suburb. "We still think of Honeywell as being a regional company, even though it merged with Allied Signal and is now based in New Jersey," Frels says.

Land of Good Companies and Talent
The Twin Cities area remains a vibrant incubator of new companies, the managers say. "I think we always start in our own backyard," Balanced fund comanager Ron Kaliebe says. Kaliebe joined the firm in 2001 after running bond portfolios for local banks and insurance companies for decades.

Luckily, their backyard has some decent inhabitants. Most of the Growth fund's holdings are dominant franchises with a lot of pricing power--86% of the fund's assets are in stocks with economic moats. Many of them are also global players--35% of the revenue of the Growth fund's holdings comes from overseas. It's a high-quality portfolio that provides more diversification than one would expect from a focused and geographically anchored fund. The Balanced fund's fixed-income portfolio provides more variety to that fund. It, too, is concentrated on 50 or fewer holdings, including some with middling credit ratings, but leans heavily on the securities from companies that share many of the same attributes of the firm's stock holdings--solid businesses with the assets and cash flow to meet their obligations. Recently, for example, Kaliebe bought convertible bonds of airlines such as Continental and Delta DAL that could put up new, fuel-efficient planes as collateral.

The firm's continued success will depend on its ability to attract and retain people capable of executing its approach. It has hired three people in the past six years--a veritable hiring spree for this firm that has pushed its investment personnel roster to an all-time high of eight.

Mairs & Power, however, has been careful to hire managers and analysts who share not only the firm's local roots but also experience and long-term focus. Like Frels, Kaliebe, Henneman, and Johnson, most of them put in years at local bank trust departments and are Minnesota natives. They're also all comfortable being generalists, in both senses of the word.

Daniel Culloton is an associate director of fund analysis with Morningstar. Josh Koeck is a mutual fund analyst.

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