Fund Spy

What Separates Primecap Odyssey Growth From the Rest?

Alec Lucas, Ph.D.

The following is our latest Fund Analyst Report for Primecap Odyssey Growth (POGRX). 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. 

Primecap Odyssey Growth is one of a select number of funds run by Primecap Management, whose fundamentals-based multimanager approach richly rewards long-term investors. It earns a Morningstar Analyst Rating of Gold.

The firm's multimanager system blends the strengths of single-manager and team approaches. It divides each fund's asset base into separately run sleeves of the overall portfolio, allowing its five managers to benefit from dialogue and debate with others while still investing in their highest-conviction ideas. Meanwhile, the combination of sleeves enhances diversification.

Diversification has it limits here, though. The managers' benchmark-agnostic search for companies with prospects for above-average earnings growth can cause their picks to cluster in certain parts of the market, especially healthcare and tech. The fund's combined exposure to these two sectors has been above 60% of assets since late 2007. As of June 2018, it was 61.6%, versus 54.2% for the Russell 3000 Growth Index.

The managers also share a contrarian bent and willingness to stick with their picks through thick and thin. Current top-25 holding  Biogen (BIIB) was the fund's top holding in early 2005, when the biotech firm suspended sales of its promising multiple sclerosis treatment and its stock shed nearly 43% in one day. The managers reassessed the firm's prospects and fortunately bought more: Through July 2018 Biogen’s stock has returned 18% annually since, versus 10.4% for the index.

Management's tolerance for painful share price drops can lead them to hold some stocks too long, and the fund’s aggressive profile has led it to struggle in down markets. Over a full market cycle, though, performance has been outstanding. Since its late 2004 inception, the fund through July 2018 has turned a $10,000 investment at the beginning of that period into about $48,200, versus $39,500 for the benchmark’s haul.

This fund and its more conservative Gold-rated sibling  Primecap Odyssey Stock (POSKX) are the only two Primecap funds still open to new investors. Both are worth a look.  

Process Pillar: Positive | Alec Lucas, Ph.D. 08/03/2018
The fund earns a Positive Process Pillar rating for its use of Primecap’s high-conviction multimanager system. It divides each fund’s asset base into separately run sleeves of the overall portfolio. Each manager practices his own form of Primecap’s fundamentals-based, benchmark-agnostic approach, but it is rooted in finding companies with superior prospects and buying them when those prospects are still emerging, largely overlooked, or clouded by controversy. Managers often stick with their picks over a decade or more and add to positions amid painful share price drops along the way. They will trim positions with stretched valuations and exit those suffering from seismic shifts at the company or industry level, but sales here are rare compared with most rivals’.

Primecap’s managers calibrate their stock picks to each of their fund’s unique attributes, including the size of its asset base. The firm’s six U.S. open-end funds form three strategic pairs.  Vanguard Capital Opportunity (VHCOX) and  Primecap Odyssey Aggressive Growth (POAGX) focus on firms with rapid earnings growth potential, though the latter holds more small caps;  Vanguard Primecap (VPMCX) and this fund focus on stocks with above-average growth potential, though the former has more large caps; and  Vanguard Primecap Core (VPCCX) and Primecap Odyssey Stock focus on firms with better-than-anticipated results ahead, mispriced assets, or turnaround potential.

This fund’s roughly 130- to 150-stock portfolio is a blend of its five managers’ separately run sleeves. The combination adds diversification while still allowing individual names to make an impact. Exposure to current top-five holding Nektar Therapeutics (NKTR) peaked at 6.3% of assets in March 2018.

The managers must build positions here with a view to ownership elsewhere in the lineup. As a firm, Primecap will buy up to 15% of a company’s shares outstanding. In March 2018, Primecap’s firmwide stake in biotech firm Alkermes (ALKS) and tech firm  NetApp (NTAP), both top-15 positions in this fund, had each hit that 15% cap.

The managers’ search for above-average earnings growth typically leads their company-level bets to cluster in healthcare and tech. The fund’s combined exposure to these two sectors has been above 60% of assets since late 2007 and it peaked at 72% in June 2012. While the fund’s tech weighting was then a bit below the Russell 3000 Growth Index’s, it had a 31-percentage-point healthcare overweight largely driven by biotech and pharmaceuticals holdings.

This fund’s mandate is similar to sibling Vanguard Primecap, but its smaller asset base gives it more flexibility. As of March 2018, this fund had a combined 33.9% stake in small- and mid-cap stocks, versus 4.5% for Vanguard Primecap. Both funds, though, are in the large-growth Morningstar Category peer group.

Performance Pillar: Positive | Alec Lucas, Ph.D. 08/03/2018 
This fund merits a Positive Performance Pillar rating for its strong, albeit volatile, long-term record. Since its late 2004 inception, the fund’s 12.1% annualized gain through July 2018 beat the Russell 3000 Growth Index by 1.6 percentage points, turning a $10,000 investment at the beginning of that period into about $48,200, versus $39,500 for the benchmark’s haul.

The fund’s aggressive profile has led to consistent outperformance. It has beaten the Russell 3000 Growth Index in 10 out of its 13 full calendar years. The fund has thrived in market rallies, including 2009, 2013, and 2017, but its best year of performance relative to the index was its first: In 2005, the fund’s 11.8% gain more than doubled the benchmark’s 5.2%. The fund’s 2005 showing is all the more remarkable given that its top holding to begin that year, Biogen BIIB, lost 43% on one day in late February after suspending sales of its multiple sclerosis treatment. In response, the managers reassessed Biogen’s prospects and bought more. That was the right call as the stock has been a long-term winner.

The flip side of thriving in rallies is that the fund can struggle in market downturns. It lost a bit more than the index during the 2007-09 financial crisis and underperformed amid 2011’s turbulence. Nor did the fund prove more resilient than the index during the 2015-16 correction. Investors must have an appetite for risk to benefit here. 

People Pillar: Positive | Alec Lucas, Ph.D. 08/03/2018
Primecap Management’s five managers and 12 equity analysts are among the industry’s most talented. The team is stable, includes a healthy mix of seasoned and more junior members, and its managers invest substantially alongside shareholders. The fund earns a Positive People Pillar rating.

Joel Fried, who allocates capital to this fund’s separately run sleeves, has managed here since the fund’s November 2004 inception, as has Theo Kolokotrones and Alfred Mordecai. M. Mohsin Ansari joined in April 2012 and James Marchetti in November 2014. Firm-cofounder Kolokotrones is the veteran of the group, with nearly 50 years of industry experience, and Marchetti its most junior member, with nearly 15 years of industry experience--all at Primecap.

The analysts divide coverage by sector and each gets a small portion of fund assets to pick stocks in his or her area of expertise. The analysts’ industry experience ranges from one year to more than 15. Most have spent the majority, if not the entirety, of their investment career at Primecap. Indeed, the firm recruits standouts at top business schools, including those without an investing background. Three more are set to join the team.

Each Primecap manager owns all six of the firm’s U.S. open-end funds. Kolokotrones, Fried, and Mordecai each investment more than $6 million across the lineup, Ansari more than $3 million, and Marchetti at least $600,000.

Parent Pillar: Positive | Alec Lucas, Ph.D. 08/02/2018 
Pasadena, California-based Primecap Management is an elite equity shop and merits a Positive Parent Pillar rating. It has its origins in another standout asset manager, Capital Group, where its three co-founders worked before striking out on their own in 1983. As at Capital Group, Primecap uses a multimanager system to run money. In other ways, the firm has distinguished itself. Its five managers and analysts are more narrowly focused on a growth-oriented approach to investing that can still be very contrarian. Primecap is also more capacity-conscious than its predecessor, as four of its six U.S. open-end funds are now closed to new investors. With $135 billion in assets, as of year-end 2017, the firm isn’t small, but it has resisted broadening its lineup by adding non-U.S. stock strategies or bond funds.

Of the original triumvirate who started Primecap, only the septuagenarian Theo Kolokotrones remains; yet the firm’s investment talent shows no signs of letting up, thanks to its best-in-class approach to recruiting. Kolokotrones and firm veterans Joel Fried and Alfred Mordecai travel in person to three top business schools each year and look for standouts who have excelled in rigorous academic fields. They invite them to apply, whether the candidates have an investing background or not. Those who join Primecap are given wide latitude to find their own way but held to very high standards.

Price Pillar: Positive | Alec Lucas, Ph.D. 08/03/2018  
Competitive fees earn the fund a Positive Price Pillar rating. Granted, between fiscal 2014 and the fund’s 2018 prospectus, fees for its sole share class ticked up 4 basis points to 0.67%. The fund is now 28 points more expensive than the investor shares of its closed and much larger sibling Vanguard Primecap. Even so, it costs 22 basis points less than the large-cap, no-load peer median and is cheaper than nearly three fourths of those rivals.

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Alec Lucas, Ph.D. does not own shares in any of the securities mentioned above. Find out about Morningstar's editorial policies.