Top Buys and Sells of Our Best-Performing Managers

By Greggory Warren, CFA | Senior Stock Analyst

With the first quarter of 2010 put to rest, we thought it would be interesting to take a deeper look at the most recent holdings, purchases and sales of those Ultimate Stock-Pickers that outperformed the market over the course of last year. We tend not to focus too intently on performance over time frames as short as a year. Instead, we prefer to put more weight on multi-year time periods whenever we're assessing our top managers. Still, we believe there is plenty that can be learned from the last year in the markets. After bottoming out in early March of last year, the S&P 500 Index  rallied strongly during the second and third quarters, returning close to 16% in each of these two quarters before posting more modest gains during the fourth quarter (6%) of 2009 and first quarter (5%) of 2010.

In a year when just about everything in the stock market rallied as strongly as the market itself did, it wasn't too difficult for our top managers to generate positive returns. Beating the benchmark index, though, which increased more than 45% (on a total return basis) from the end of March 2009 to the end of March of this year, was a more formidable hurdle. Of the 22 fund managers we track, a little over half of them--12 funds in total--beat the S&P 500 Index over the last year. Wanting to narrow the list down to a more manageable level, we decided to look at only those funds that had beaten the index by a sizable margin--in this case, 400 basis points--during the last year. This produced a list of six fund managers:  Yacktman ,  Fairholme ,  Columbia Value & Restructuring ,  Dodge & Cox Stock ,  Hartford Capital Appreciation , and  Oak Value .

While Bruce Berkowitz may be getting a lot of the attention these days, following up being named Morningstar's Domestic-Stock Manager of the Year and Domestic-Stock Manager of the Decade with a nearly 13% return in his Fairholme fund during the first quarter of 2010, it is still impressive to see a handful of other managers also outperforming the market on a fairly consistent basis. Even more impressive is the fact that each of these managers seems to have taken a slightly different tack in order to reach this goal. Fairholme, for example, went from having nearly half of its portfolio in health care names during the first quarter of 2009 to less than 10% during this year's first quarter. Berkowitz completely eliminated what had been a very high profile sale of  Pfizer , and sold out positions in  Forest Laboratories  and  WellPoint  as well.

Berkowitz and Yacktman Get Busy
Fairholme put much of this money to work in the financial services sector, which Berkowitz believes has a much more attractive risk-reward tradeoff than other sectors, making significant new money purchases of  Bank of America ,  Regions Financial , and CIT Group , and large follow-on purchases of  Berkshire Hathaway  /  and  Citigroup . Berkowitz has also been building a stake in  American International Group  through purchases of the insurer's common stock, convertible preferred stock, and other debt. Over the course of the last year, Fairholme made significant reductions to its sector weightings in energy and industrial materials, while increasing its exposure to media and consumer services. The fund's largest holding at the end of the most recent period was  Sears Holdings , which accounted for more than 15% of the total stock portfolio (having run up more than 150% from its March 2009 lows). With its top ten holdings accounting for more than 75% of the total stock portfolio, Fairholme remains a fairly concentrated fund.

Contrast this with Yacktman, which (while having close to two thirds of its total stock portfolio tied up in its top 10 holdings) has been able to generate performance on par with Fairholme's over the last year, with a more balanced focus on consumer goods and services, financial services, and health care. Four of Yacktman's top ten holdings-- PepsiCo ,  Coca-Cola ,  Clorox , and  Procter & Gamble --at the end of the most recent period are consumer goods names. Fund managers Donald and Stephen Yacktman made significant additions to Coke, Pepsi and Clorox during the quarter, while putting new money to work in  Sysco , a consumer services firm that is a major foodservice distributor to restaurants, health-care and educational facilities, and lodging establishments. The fund also put new money to work in two health care names,  C.R. Bard  and  Becton Dickinson , with the latter being not only one of the few 5-Star names we came across in the holdings of these six managers but also a long-standing top buy idea of our analyst Alex Morozov.

Looking for Value in Different Places
The path to outperformance taken by Columbia Value & Restructuring involved heavier commitments to energy, financial services, and industrial materials. The fund is far less concentrated than either Fairholme or Yacktman, with the top ten holdings accounting for a little over one third of its total stock portfolio at the end of the most recent period. Manager David Williams has no aversion to mixing things up either, holding large- and mid-cap stocks almost as equally as growth and value names. The same could be said about Hartford Capital Appreciation, where the top ten holdings of the fund make up 30% of the total stock portfolio, with names like  Ford ,  Wells Fargo , Pfizer,  Cisco , and  Dow Chemical  representative of the types of stocks in the portfolio. Fund manager Saul Pannell's focus on finding reasonably priced stocks with great growth opportunities has him concentrating the portfolio on four main sectors--consumer goods, financial services, health care, and industrial materials. Hartford's most recent new money purchases included  Corning , Rosetta Resources , and Citigroup.

The biggest sector bet Dodge & Cox Stock made over the last year has been on health care, which accounted for slightly more than 20% of the stock portfolio at the end of the first quarter. The fund's two largest health care positions were in  Novartis  and  Merck , with the latter being a new addition to the portfolio during the first quarter of 2009. That said, managers John Gunn and Ken Olivier still run a fairly diverse portfolio, with the remaining 80% of the fund spread out among ten other sectors. Moreover, the top ten holdings in Dodge & Cox Stock at the end of the most recent period accounted for a little over one third of the total portfolio, with  Hewlett-Packard  being its largest holding (at close to 5% of the fund). When selecting investments for the fund, Gunn and Olivier look for companies that they believe are temporarily undervalued by the market but which they feel still have favorable long-term growth prospects. Dodge & Cox Stock made one new money purchase during the first quarter in discount broker  Charles Schwab .

Finding Advantaged Businesses at Oak Value
Running a slightly more concentrated fund, the mangers at Oak Value focus on identifying and investing in a select few advantaged businesses that are run by able management teams, but only when those businesses can be bought at very attractive valuations. While the fund has been weighted more heavily towards financial services, consumer goods, and industrial materials over the last year, it has also maintained meaningful allocations in business services, software, and health care. Oak Value's top ten holdings accounted for a little over half of the stock portfolio at the end of the most recent period. While the pickings remain slim following the run-up in the markets over the last year, managers David Carr, Larry Coats, and Christy Phillips were able to find a few "advantaged" businesses trading at attractive prices. New money purchases during the quarter included  Thomson Reuters ,  Teva Pharmaceutical , and  CME Group . The fund also made outright sales of  Aon ,  XTO Energy  (which is being acquired by  ExxonMobil ), and  Microsoft , with the latter two being more valuation driven and the former being a case of selling because the thesis would take longer to work out that the managers had originally anticipated.

Highest Conviction Purchases of Best Performing Fund Managers

Stock Price and Morningstar Rating data as of 04-30-10 unless otherwise noted. 

When taken in aggregate, the top 10 purchases of our best performing managers during the latest period were concentrated in financial services, with five of the names coming from the sector. Fairholme's significant new money purchases of three of the stocks--Bank of America, Regions Financial, and CIT Group--and meaningful addition to Citigroup had a big influence on this outcome. While we haven't made much mention of the media purchases during the quarter, two of our managers--Fairholme and Yacktman--were either building or adding to existing stakes in  Comcast , which had fallen off after the company announced its deal to acquire NBC Universal (from  General Electric  and Vivendi ). Yacktman made significant new money purchases in  News Corporation , C.R. Bard, and Sysco, and was also the largest acquirer of shares of Coke during the quarter.

Highest Conviction Sales of Best Performing Fund Managers

Stock Price and Morningstar Rating data as of 04-30-10 unless otherwise noted. 

The sales were also heavily influenced by Fairholme, which blew out positions in WellPoint, Forest Labs, and Pfizer. As we noted, Aon was an outright sale at Oak Value, which also cut its stake in  ITT Educational Services  by more than half and put the proceeds into an existing position in  Apollo Group . The managers at Oak Value had added Apollo to the portfolio during the second quarter of 2009 for what would be the third time in three years, and made a meaningful new money purchase in ITT Educational Services during the third quarter of last year. Their willingness to sell positions that have either run up in price, or where the thesis is faltering, may have prompted the managers to make the swap from ITT Educational Services to Apollo Group, which has generally been viewed as the leader in the for-profit education industry. Oak Value made a similar move in the health care sector, cutting its position in Medtronic by more than half, and putting the proceeds to work in drug wholesaler Teva Pharmaceutical. Meanwhile, Merck was a fairly significant sale at Hartford, which also blew out positions in ExxonMobil and  Staples  during the quarter.

Disclosure: Greggory Warren owns shares in the following securities mentioned above: Becton Dickinson and Procter & Gamble.