Long-Term Outperformance Is the Norm at This Large-Cap Fund

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

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. The combination of sleeves enhances diversification.

Diversification has it limits here, though. The managers' search for better-than-anticipated results, mispriced securities, and turnaround plays means this fund has more of a core focus within Primecap's growth-oriented lineup, yet company-level bets here also cluster in healthcare and tech. The fund's combined exposure to these two sectors has long hovered around 40% to 50% of assets.

The managers also share a contrarian bent and willingness to stick with their picks through thick and thin. The fund's top-40 stake in Biogen BIIB was big enough to hurt when Biogen's share price on March 21, 2019, plummeted 29.2% on news it was stopping late-stage trials of an Alzheimer's treatment. The managers endured an even more severe drop in Biogen's share price in early 2005 and held on then, which was the right call. They've held on now, too, and will get added help in evaluating Biogen's prospects when a veteran biotech analyst starts on Aug. 1. The fund benefits from the insights of another biotech analyst and managers with ample experience in the space.

Tolerance for painful share price drops can lead to holding some stocks too long and poor short-term performance, as it has of late. Yet, over a full market cycle, the fund has been strong. Since its 2004 inception, the fund's 10.1% annualized gain through June 2019 beat the Russell 3000 Index by 1 percentage point.

This fund and Gold-rated sibling Primecap Odyssey Growth POGRX are the only two of six Primecap funds that are open to new investors.

Performance: Positive | by Alec Lucas, Ph.D. July 28, 2019

This fund merits a Positive Performance rating for its strong long-term record. Since its late-2004 inception, the fund's 10.1% annualized gain through July 2019 beat the Russell 3000 Index by 1 percentage point, turning a $10,000 investment at the beginning of that period into nearly $41,000, versus nearly $36,000 for the benchmark’s haul.

Outperformance has been the norm. The fund beat the Russell 3000 Index in nine out of its 14 full calendar years. The fund’s 2007-09 credit crisis era showing deserves special mention. Thanks in part to a double-digit-financials underweighting through much of that bear market, its 50.1% peak-to-trough cumulative loss was 5.4 percentage points better than the index. When the market surged after its March 9, 2009, bottom, the fund kept pace and its 37.9% calendar-year 2009 gain beat the index by 9.5 percentage points.

Underperformance hasn't been as pronounced, but it hasn't been absent. Relative to the index, the fund had its worst year in 2010: Its 11.8% gain lagged by 5.1 percentage points. The fund also suffered a two-year slump from 2006 to 2007. Thus far, 2019 has been another tough stretch. Biogen BIIB wasn't as big a position here as in sibling strategies, but the fund's top-40 stake still hurt the overall portfolio when Biogen's share price on March 21, 2019, plummeted 29.2% on news it was stopping late-stage trials of an Alzheimer's treatment.

Price: Positive | by Alec Lucas, Ph.D. July 28, 2019

Competitive fees earn the fund a Positive Price rating. Between fiscal 2014 and the fund's 2019 prospectus, fees for its sole share class ticked up 4 basis points to 0.66%. The fund is now 20 points more expensive than closed sibling Vanguard Primecap Core VPCCX. Even so, it costs 22 basis points less than the large-cap, no-load peer median and is cheaper than three fourths of those rivals.

Trading costs are competitive, too. In fiscal 2018, brokerage fees as a percentage of average net assets were 0.02% versus 0.03% for the category median.

Investors in taxable accounts have been hurt by capital gains distributions each year since 2013, but they have been fairly modest. They ranged from 0.3% of net asset value in December 2013 to just above 1.7% in December 2018.

Process: Positive | by Alec Lucas, Ph.D. July 28, 2019

The fund earns a Positive Process rating for its use of Primecap Management’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 more than a decade and hold fast on, if not add to, positions during 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; Vanguard Primecap VPMCX and Primecap Odyssey Growth POGRX focus on stocks with above-average growth potential; and Vanguard Primecap Core VPCCX and this fund focus on firms with better-than-anticipated results ahead, mispriced assets, or turnaround potential.

This fund's roughly 110-130 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. Top positions can reach 5% of assets but rarely exceed that figure.

The managers, though, 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 2019, Primecap's firmwide stake in data storage equipment vendor NetApp NTAP, a top-10 position in this fund, was near that 15% cap.

The managers' search for better-than-anticipated results, mispriced securities, and turnaround plays means this fund has more of a core focus within Primecap’s growth-oriented lineup, yet company-level bets here also tend to cluster in healthcare and tech. The fund's combined exposure to these two sectors has hovered at 40%-50% of assets since its late-2004 inception. As of June 2019, its combined weighting was 45% versus 35.5% for the Russell 3000 Index. Airlines stocks have been a favorite here, too.

This fund switched to its current large-blend Morningstar Category from large-growth in December 2012. Sibling Vanguard Primecap Core VPCCX made the same category switch in October 2018. The two Primecap funds have similar mandates, though this one is more of a multi-cap offering.

People: Positive | by Alec Lucas, Ph.D. July 28, 2019

Primecap Management's five managers and 16 equity analysts are among the industry's most talented. The team is stable, it includes a healthy mix of seasoned and more junior members, and its managers invest substantially alongside shareholders. The fund earns a Positive People rating.

Alfred Mordecai, who allocates capital to this fund's separately run sleeves, has managed here since the fund's November 2004 inception, as have Theo Kolokotrones and Joel Fried. M. Mohsin Ansari joined in April 2012, and James Marchetti in November 2014. Firm co-founder Kolokotrones is the veteran of the group, with nearly 50 years of industry experience. 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. Many have spent the majority, if not the entirety, of their investment careers at Primecap. The firm typically recruits standouts from top business schools but recently hired a veteran biotech analyst, who starts Aug. 1, 2019.

Each Primecap manager owns all six of the firm's U.S. open-end funds. Kolokotrones, Fried, and Mordecai each invest more than $6 million across the lineup, Ansari more than $4 million, and Marchetti more than $2 million.

Parent: Positive | by Alec Lucas, Ph.D. Aug. 2, 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.