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Buy, Hold, and Fold

Jason Stipp

Jason Stipp: I'm Jason Stipp with Morningstar. Legg Mason ClearBridge Appreciation Fund is a 4-star, large-blend fund with a 40-year history. We recently sat down with management, including Scott Glasser, a 14-year veteran of the fund, and Michael Kagan, to talk about how they managed through the downturn and where they're seeing opportunity today.

Stipp: Your fund, Legg Mason ClearBridge Appreciation, follows a buy-and-hold strategy and seeks high-quality names. After the market's recent downturn, many now claim that the concept of "buy and hold" is dead. What do you think of that assertation? 

Scott Glasser: Well see, I'm going to change the definition of that. I would say that this is not a buy-and-hold fund. Traditionally it's run a turnover ratio between 30 and 50 percent, which means we're keeping stocks, on average, two to three years. There are certain stocks, like cyclical stocks, that you buy with the intention of selling at some point in the future.

And we do that with cyclical stocks. We know why we buy it and when that valuation is realized or when there's a catalyst that realizes the valuation, then we'll sell the stocks.

There are certain stocks, like a Wal-Mart, like a Johnson & Johnson, that we feel very comfortable owning for long periods of time, because the whole idea of these type of stocks is consistency over time. Now sometimes their business models or their businesses will be in favor; sometimes they'll be out of favor and the stock price will go up and down and reflect that.

But these are core holdings, in our mind, that we want to own for our investors for longer periods of time. So, it's really a combination of these core holdings and then other holdings where you will see more turnover.

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Michael Kagan: What I would add is that our research effort is focused on understanding the fundamentals of the companies that we invest in. So, what we're looking for is not just whether a company is going to beat next quarter's earnings, but what are the fundamental drivers that create value over time.

So an example would be: three years ago we went out to visit Wal-Mart in Bentonville, Ark. And we went out there--we did not own the stock at the time. We didn't own the company, because we were concerned that there was a deterioration, over many years, in their return on invested capital on the stores.

So, what we wanted to do... There had been a lot of discussion over the previous year about re-merchandising and changing the strategy aimed at improving it. So, we wanted to test that thesis and find out what the company was really doing. We came away from that... What they said, actually, was that they had changed their accounting and made it more conservative.

So that, in fact, return on vested capital in the stores had not only stabilized in the previous year, but it had started to improve. And then were able to go and to demonstrate to us what were the things that they did and how they would cause sustained improvement over time.

So, we made a very large investment at Wal-Mart at that time, and it wasn't for one year, it was for a long time, because we think that those returns are going to continue to rise and that they're going to continue to create value.

Scott Glasser: If I could just follow up, our sell decisions are very much based, first and foremost, on fundamentals and whether things are continuing to improve or playing out as we see them or whether, in fact, they're deteriorating. So, our first decision on a longer-term basis, not on a short-term basis, whether to hold or sell a stock, is going to be based on how those fundamentals are unfolding.

The second reason we primarily will sell a stock is valuation. If we think the valuation is extended, then we will first pare back on the stock and then secondarily, if it continues to run, then sell the stock. So, we are fundamental players. Research is incredibly important, too, to our process and that kind of is the core of what we do and that determines, very much, our turnover over time.