This Large-Growth Fund Isn't Afraid to Go Its Own Way

The following is our latest Fund Analyst Report for Akre Focus Fund AKREX. Morningstar Premium Members have access to full analyst reports such as this for more than 1,000 of the largest and best mutual funds. Not a Premium Member? Gain full access to our analyst reports and advanced tools immediately when you try Morningstar Premium free for 14 days.

Akre Focus receives a Morningstar Analyst Rating of Silver for its ability to take advantage of market opportunities.

Lead manager Chuck Akre and comanagers Tom Saberhagen and John Neff pay close heed to the business fundamentals of the fund’s roughly 20- to 30-stock portfolio and add to positions whenever they believe a share price drop reflects undue pessimism. For example, when weaker-than-expected same-store sales led

Akre and his team combine a willingness to act decisively with a buy-and-hold philosophy focused on companies like O’Reilly. In addition to sustainable competitive advantages, it has high free cash flow, strong management, and the ability to reinvest cash at superior rates of return. O’Reilly has been in the portfolio since early 2010 and the fund’s annual turnover has ranged from 10% to 30% each fiscal year, well below the large-growth Morningstar Category norm.

The managers’ approach entails significant security-specific risk. Top positions often exceed 10% of assets and the fund sometimes keeps even bigger combined stakes in companies with similar businesses. As of September 2017, the fund’s positions in cell tower operators

Not all of management’s high-conviction picks work out. The fund underperformed during the 2015-16 correction, for example, in part because industrials firm Colfax CFX proved more sensitive to commodities than anticipated. That sensitivity plus a leadership change at Colfax led Akre and his team to sell the stock in mid-2017.

Overall, though, the managers have made good picks. The fund’s near top-quartile showing for the year to date through November 2017 is in keeping with its long-term record.

Process Pillar: Positive | Alec Lucas, Ph.D. 12/01/2017 Lead manager Chuck Akre and his team use an effective, high-conviction approach that merits a Positive Process Pillar rating. Akre aims to compound capital at an above-average rate while incurring a below-average level of risk. He looks for sturdy firms that can grow capital over long periods, which he calls "three-legged stools." The first leg is a business model that produces high free cash flow and has sustainable competitive advantages. The second leg is strong shareholder-oriented management, and the third is the ability to reinvest cash at a superior rate of return.

While valuations play an important role in purchasing such companies or adding to positions in them, Akre usually won't sell based on valuations alone because he believes firms that compound capital come through in the long run. However, if a firm is more cyclical than his typical holding or its margins are less dependable, he's quicker to sell.

The fund's focused portfolio leads it to behave differently from any index. During the past three years through October 2017, it had an R-squared of 87.2 with its most closely correlated index, the Russell 3000 Growth Index. The fund can also set itself apart with a big cash stake. Akre often holds a high-single-digit to mid-teens stake in cash and bonds so that he won't be forced to sell to meet redemptions and so he can buy stocks that dip to attractive prices.

Since few firms meet manager Chuck Akre's standards, his funds have always had concentrated portfolios. Following this fund's 2009 inception, the number of stocks in the portfolio steadily climbed to 26 by July 2010. Since then, the portfolio has held between 20 and 33 stocks, with its biggest positions often exceeding 10% of assets each. As of September 2017, the portfolio held 24 stocks, with the top-10 holdings accounting for 76% of assets.

The portfolio shows Akre's emphasis on investing in firms that are well positioned and have sustainable competitive advantages. For example, since early 2010 he’s kept a big position in

Akre and his team seize the opportunity to add to positions whenever they believe a share-price drop reflects undue pessimism. For example, when weaker-than-expected same-store sales led O’Reilly Automotive’s stock to plunge more than 20% over a three-day span in July 2017, Akre tripled the fund’s number of shares because he believes O’Reilly’s distribution network insulates it from would be disruptors.

Performance Pillar:

Positive | Alec Lucas, Ph.D. 12/01/2017

Chuck Akre's high-conviction approach leads to concentrated portfolios and often large cash stakes as he searches for the few firms that meet his criteria. As a result, his funds do not hug their benchmarks and may go through periods of underperformance while still outperforming over the long term. Prior all-cap charge FBR Focus (now

This fund's record merits a Positive Performance rating. It started slowly in late 2009 and 2010 as Akre took time putting cash to work. Since mid-2011, however, the fund has fared well. During the past five years through November 2017, the fund's 17.6% annualized gain beat the Russell 3000 Growth Index by 55 basis points and ranked near the top decile of all mid-growth and large-growth category peers combined (the fund’s portfolio places it near the borderline of these two groups). The fund won't shine in liquidity-driven rallies, but the cash-generative firms it owns tend to reward investors over the long haul.

People Pillar: Positive | Alec Lucas, Ph.D. 12/01/2017 Chuck Akre's experience and track record merit a Positive People rating. In 1968, he joined Johnston, Lemon & Co. and eventually became CEO of the firm's asset-management division and director of research. In 1989, he founded Akre Capital Management, which was associated with FBR Group from 1993 to 2009. During his 12-plus years managing FBR Focus, Akre guided the fund to stellar returns with below-average volatility. After his departure, Akre's former analysts became the fund's comanagers. Now called Hennessy Focus, these analysts have used the same process to deliver strong returns.

The success of Akre's former analysts bodes well for the long-term future here. It shows Akre's ability to train younger investors, something he's done since hiring analysts Tom Saberhagen and John Neff when this fund started in late August 2009. The two became comanagers in August 2014, and their promotion clarifies the path of succession should Akre decide to retire. Prior to joining the firm, Saberhagen had worked at Aegis Financial since 2002 and Neff for several years at William Blair and before that at two other firms. Akre and his comanagers share coverage duties with three analysts. Chris Cerrone joined in April 2012, while Deanna McGreevy and Ben Fox both started in 2014. Each came with experience.

Akre, Saberhagen, and Neff each invest more than $1 million in the fund.

Parent Pillar: Positive | Alec Lucas, Ph.D. 05/30/2017 Akre Capital Management has adeptly navigated several changes since the early 2000s. Founded in 1989 by industry veteran Chuck Akre, the firm entered into a partnership with FBR Group from 1993 to 2001. As an employee of FBR, Akre became manager of FBR Focus in late December 1996 and developed an outstanding track record. In 2002, Akre re-established as independent firm Akre Capital Management, which became the subadvisor to FBR Focus. This relationship lasted until August 2009, when changes in FBR caused the two firms to part ways.

Akre Capital Management has since established a sound investment culture centered on the Akre Focus Fund. Its retail (AKREX) and two institutional (AKRIX, AKRSX) share classes accounted for most of the firm's roughly $6 billion in assets as of early 2017. Chuck Akre continues to be a driving force, but he also now shares investment duties. Firm partners Tom Saberhagen and John Neff, who started as analysts in 2009, have served as portfolio managers since 2014. In that same year, analyst Chris Cerrone became a partner, having joined in early 2012. The firm has also added both investment and noninvestment personnel in recent years, making it less likely that the firm's lofty fees will come down in the near future.

Fees could be more competitive, but the firm as a whole serves investors well and merits a Positive Parent rating.

Price Pillar: Negative | Alec Lucas, Ph.D. 12/01/2017 Fees have trended downward over the past five years but are still high, earning the fund a Negative Price rating. The retail shares' 1.33% expense ratio, which applies to more than half of the assets, is 43 basis points above the large-cap, no-load peer median. The two institutional share classes, which differ in their minimum investment levels of $250,000 and $300 million, have expense ratios of 1.05% and 0.96%, respectively, versus the 0.76% peer median.

Lofty fees are a drawback here. The fund consistently has modest brokerage costs, though, because of its low turnover. In fiscal 2017, these costs amounted to 1 basis point, which was 3 basis points below the category median. A 1.00% redemption fee for shares held 30 days or less also protects against short-term speculators.