Shannon Zimmerman: For Morningstar, I'm Shannon Zimmerman. I'm here today with Evan Bauman of Legg Mason ClearBridge Aggressive Growth.
Evan, thank you very much for being with us today.
Evan Bauman: My pleasure, Shannon, good to be here.
Zimmerman: You manage Aggressive Growth with the veteran manager Richie Freeman, and the fund had a bit of rough patch between 2007 and 2009 but has lately returned to form in a big way. It's up about 30% over the last 12 months, which is near the top of the large-growth category, with a similar performance in terms of relative ranking so far year-to-date. Could you talk a little bit about what's behind the return to form?
Bauman: Sure. So, this is a portfolio that started in 1983, has a 27-plus-year track record, and Richie, my partner, has been at the helm of the fund for all 27-plus years. The last few years have been positive because some of the companies that we own have been doing very well, and that's the key. We're very long-term investors. We really try to buy and hold onto companies for many, many years. Some of our positions have been in the fund for more than 20 years, and it's really just a case of the companies executing and continuing to grow in the slow-growth environment, and the market starting to recognize that. In some other cases we've had some takeovers in the portfolio. So, while the market has recognized the value as well third parties have come along and recognized the value of some of our holdings, which results in a nice premium and a nice takeover premium in that case.
Zimmerman: Looking at the portfolio relative to the benchmark and to the peer group as we define it, it has a pretty significant overweight stake in health-care names. I know from earlier conversations that that's not by sector-level design. You guys are really bottom-up investors, yet it's a pretty sizable allocation. Can you talk a little bit about your approach to security selection and then maybe in the context of how you manage the risk that can come with large sector allocation?
Bauman: Sure. As you said, all overweights and underweights are just a byproduct of stock selection. We're really bottom-up, benchmark-agnostic managers. There are areas that we own in size and there are other areas that we don't own at all. In the health-care space particularly, we really focus on the biotech companies, and those companies that are treating unmet medical needs, big unmet needs with novel treatments for those diseases. So, to us that's a great way in a slow-growth environment economically to show earnings growth, is having successful products, treating these unmet needs, and diseases like MS and cancer and Alzheimer's disease that don't have treatments right now or current cures, enable these companies to continue to grow even during slow times.
Zimmerman: Right. Looking at the portfolio's top 10, the biggest health-care position is not actually a biotech, it's UnitedHealth, an insurer. Can you talk a little bit about your approach to securities selection in the specific context of that name? What is especially attractive about UnitedHealth given the way you and Richie approach picking stocks?
Bauman: Sure. It's the size and the scale of the company. It's a nationwide company that has had enormous success in terms of earnings growth and free cash flow growth. They've survived the health-care reform. The stock got hit a couple of years ago, everybody thought the insurers would get hurt, but actually their earnings and their cash flows have significantly exceeded expectations over the last couple of years, and we believe it's their size and scale, as well as their positive management team, that has enabled them to continue to grow in this environment. They've been part of the solution rather than part of the problem.
Zimmerman: Well, scale for UnitedHealth is going to be clearly an advantage right because over time if reform works the way that it seems like it may, there's going to be a larger pool of customers for them.
Bauman: That's right, and that doesn't really kick in until 2013 and '14, but the costs have continued to come down. They have been able to charge premiums and to continue to grow again based on their national presence.
Zimmerman: Let's sort of bank shot off of that, and talk more broadly about your approach, when you do valuation work [when] fundamentals of the company erode, what's your approach to security selling or trimming in this case of a very, very low turnover fund?
Bauman: Sure. The best way to say it is, you try to buy cheap valuation and trim rich valuation. As well, we try to sell when there is a better place for the monies. Now as a long-term owners, as long-term investors in business models, typically the best idea or the best thing that we can do is hold on to something or buy on weakness.
We will trim when a position becomes too large a percentage of the fund. Over 10% we have an automatic trimming discipline, but for the most part we do take big positions, and when they are down, typically it's a good opportunity to buy more, and that's the way we've built the portfolio over 27 years is take the approach of holding forever, almost in the Buffett manner of holding for 20-plus years, and when momentum players start to buy our stocks, we're usually selling them a little bit, but the real process is to hold on forever.
Zimmerman: Well, that really is reflected in the fund's turnover rate, which over the past decade, which is the data that I looked at, single digits all the way.
Bauman: Yes, and I think the best way to describe it is we act when there is a reason to act. We don't target a turnover number. We don't have a number in mind that we want to make sure we meet. There will be times like the cyclical lows in '08 where we add a number of new positions, and there will be other times back in 2000 where we were trimming back some positions aggressively if valuations are excessive, but we really do take that bottom-up long-term approach as opposed to targeting a specific alpha number or a specific turnover number as well as the weightings versus the benchmark. Everything is just very bottom-up.