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How Artisan Beat the Pack in Down and Up Markets

Greg Carlson

Greg Carlson: Hi, I'm Greg Carlson. I'm a fund analyst with Morningstar. I'm here today with two of the managers of the three value funds from the Artisan Funds. There's Artisan Mid Cap Value, Artisan Small Cap Value, and Artisan Opportunistic Value.

Here today we have Scott Satterwhite and Jim Kieffer. Welcome. Thanks for joining me today.

Scott Satterwhite: Thanks, Greg.

Carlson: Now, you tend to be long-term-oriented investors, but I think one interesting thing is that the funds, particularly Small Cap Value and Mid Cap Value, did something fairly unusual in that they held up significantly better than their category rivals and their benchmarks in the downturn, particularly 2008. Yet they've also managed to outperform in the rally of 2009 when things significantly turned around.

I wonder if you could talk about how that has happened, and also why Opportunistic Value, which focuses on large and mid-cap companies, didn't do quite as well in the downturn but has bounced back strongly in the rally.

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Satterwhite: A lot of moving parts, obviously, in 2008. In a lot of ways, it was two years in a year. The first half of the year was reasonably strong in a lot of the sectors.

In Mid Cap and in Small Cap in particular we benefited from owning a lot of energy stocks, and those two strategies--we didn't own any bank stocks or any of the brokers that got into so much trouble with the derivatives and whatnot. So we held up very nicely in the first half of the year coming into the credit crunch of the Q3 and Q4.

Jim had mentioned an important part of the strategy is focusing on financial strength in our investments, and that paid big, big dividends in that downturn. So that protected us in the last half of the year.

As stock prices were very weak in Q3 and in Q4, that gave us the opportunity to pick up what other people were tossing out, out of fear. A lot of them were cyclical types of businesses that were under a lot of pressure because their earnings and earnings expectations were under a lot of pressure.

So we were able to come in and sell some of the more stable holdings that we had and get exposure to some more cyclical types of stocks in that period of time. That opportunity actually lasted until the first couple of months of 2009.

We were very well positioned, as it turned out, for the rally that has taken hold since March. Also, particularly in Small and in Mid in 2009, the bank stocks have done very poorly in those sectors relative to the indexes.

So it's been a mix of finding value where other people were fearful, coming into a tough period with a portfolio full of stocks that had great balance sheets, and avoiding a lot of the pitfalls. We've had a good performance in the downturn and have bounced back pretty strongly.

You had mentioned the Opportunistic strategy had not performed as strongly. We actually came into 2008 in that strategy with some of the banks that we had accumulated in the 2007-2006 period.

We were in the process of exiting those as the financial condition of those institutions was clearly deteriorating. We were pretty much out of most of those kinds of stocks by the first quarter of 2008. They punished us a little bit in that period.

With the funds from those sales, what was interesting to us at the time was a fair number of technology stocks that in our view were being offered pretty cheaply there in the first half of 2008. Those stocks performed horribly in the back half of 2008, but those stocks too have performed very strongly here in 2009 and have helped that strategy bounce back.

Carlson: I think it's worth mentioning probably that Opportunistic Value tends to be more concentrated, and actually, your funds get more concentrated the further up the market-cap spectrum you go. So the Small Cap Value is the most diversified, and Opportunistic Value is pretty concentrated.

Do you expect over time that Opportunistic Value may be a little more volatile or at least diverge a little more from its peers in the benchmark because of its concentration?

Satterwhite: Yes, it'll probably produce a little bit lumpier--it's not hugely concentrated. We're running 35 stocks in there. The weightings tend to run from 4% or 5% at the max, really, down to around 1% or 1.5%. So it's not hugely, hugely concentrated, but yes, we're running some fewer stocks, so probably by its nature, it'll produce a little bit lumpier return.

We feel in the bigger-cap areas that you have to diversify less. Down in the small-cap area, you're talking about riskier businesses, riskier business situations, and so you need to diversify more. But as you move up cap-scale, you get into bigger, more robust businesses. You can diversify less by number of names.

Jim Kieffer: If I can add one thing to that, we are diversified in order to reduce the significance of business risk. I think when you move your diversification of a large-cap portfolio beyond that, you're potentially diversifying yourself against your risk versus other peers.

That's not the risk we're guarding ourselves against. We're interested in guarding ourselves against the business risk.

Carlson: OK. Well, thank you very much for joining me today.

Satterwhite: Great. Thanks a lot.

Kieffer: Thank you.