Big Funds With Big Bets on Financials
These noteworthy offerings have substantial stakes in this unloved and undervalued sector.
These noteworthy offerings have substantial stakes in this unloved and undervalued sector.
Financial-services firms, at the epicenter of the recent economic crisis, not only suffered some of the worst bear-market losses but have also failed to stage as strong of a rebound as the broad market since early 2009. During the past three years, the typical stock in the sector has lost 7% on an annualized basis, whereas the S&P 500 has squeaked into the black during that time period. Financials stocks have also led the recent sell-off, skidding 5% during the past month alone.
There are fundamental reasons the companies have struggled. In a recent report, Morningstar financial equity analyst Jim Sinegal mentioned some key risks that might contribute to investors' continued aversion to financials, including the European sovereign debt crisis, regulatory and legal uncertainties, and credit issues born out of stunted asset and revenue growth. In fact, even those investors who didn't lose money in the global financial crisis "have essentially sworn off the stocks, much like Mark Twain's cat avoiding all stoves after sitting on a hot one," Sinegal wrote.
But times of trouble can also create opportunity. Even though Sinegal thinks the sector isn't as undervalued as it could be, given the long list of potential headwinds, Morningstar's stock analysts think that the financials in their coverage universe, on average, are trading about 10% below our analysts' estimates of their fair value. That's pretty compelling when you consider that they think the market overall is trading roughly in line with their fair value estimates.
Sinegal wrote, "Some of the highest-quality names, such as Wells Fargo (WFC) and J.P. Morgan (JPM), are well capitalized, profitable, and still trading at significant discounts to our fair value estimates and reasonable multiples of current earnings--even without future improvement. We think that in many cases, investors are being fairly, if not amply, compensated for all of the risks facing the sector."
Considering Sinegal's statements, we turned to the Premium Fund Screener to seek out funds that shared the same sentiment and have loaded up on the financial-services sector. First, we screened for single share classes of nonindex domestic-stock funds that had more than 20% of their portfolios in financial services. (For context, the typical S&P 500 index fund has about 15% in the sector. We then filtered for funds that were open to new investments of less than $10,000 and have sizable asset bases of more than $500 million. Additionally, we layered on screens for funds with available Analyst Reports and kicked out both closed and institutional funds. On the fees front, we looked for no-load funds sporting price tags cheaper than the category average. Finally, we called up offerings whose managers have had at least five years of experience behind the helm. This screener yielded 19 offerings. We've highlighted three of those below. To replicate this screen, click here.
Fairholme (FAIRX)
The spotlight has recently been on Bruce Berkowitz, who has significantly upped his financials stake and currently holds nearly 75% of the fund's assets in the financial-services sector. Berkowitz' bold and contrarian moves have caused the fund to stumble in the recent months--it lands in the bottom 1% of its peer group for the past year. As a result, it saw massive outflows of $300 million dollars in March and another $1 billion in April after about $1.2 billion entered the fund in January and February of 2011. Indeed, Analyst Kevin McDevitt mentions that it's important for shareholders to share Berkowitz' conviction; otherwise, the fund might not be appropriate for them or should be a satellite holding rather than a core. But for risk-tolerant investors who have the conviction to trust Berkowitz in both the good times and the bad, this fund remains a fine long-term core investment.
FAM Value Investor (FAMVX)
This mid-blend fund's managers, Thomas Putnam and John Fox, have long had a sizable position in financials: In fact, as of March 31, 2011, the fund had a whopping 33.23% wager on the sector--well more than double its category average. Still, they keep a lid on risk by seeking undervalued but economically sustainable companies with healthy balance sheets, high margins, and promising growth potential. As a result, the portfolio features an impressively low debt/total capital ratio and higher-than-average return on assets (a measure of profitability) than its mid-blend category peers. Investors seeking a solid, tax-efficient offering with reliable downside protection will find this offering to be a strong contender.
Royce Total Return Investment (RYTRX)
Lead manager Chuck Royce keeps a sprawling portfolio of nearly 420 small- and micro-cap stocks; even top holdings consume less than 1% of assets. This doesn't mean that the fund is diversified across sectors and industries, however. The fund has a 26% stake in the financial-services sector, a stake nearly twice that of its small blend category average. Royce insists on dividend-paying firms because he thinks that such companies strive toward improving their margins by limiting hiring and capital expenditures. That criterion, along with the fund's diversification, has cushioned the fund during market downturns. Although it's prone to lag when more speculative fare is in vogue, investors can take comfort in its extremely experienced manager, sensible strategy, and appealing long-term track record.
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