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A Stock Fund Run by Standout Managers

Primecap Odyssey Growth's successful high-conviction multimanager system contributes to its Gold rating.

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 benchmark-agnostic funds run by a standout asset manager. Its sole share class 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. The combination of sleeves enhances diversification.

Diversification has it limits here, though. The managers' search for companies with prospects for above-average earnings growth often leads them to small- and mid-cap stocks and can cause their picks to cluster in certain industries, such as airlines. Indeed, at year-end 2019, the fund's 8.3% airlines stake was the second highest out of roughly 370 large-growth Morningstar Category peers.

The managers' tolerance for extreme volatility lets them stick with their picks as long as they think the companies are good long-term investments. With the coronavirus pandemic decimating travel-related industries in early 2020, the managers in the first quarter largely held fast to their airline holdings, including a top-20 position in Southwest Airlines LUV. They like the industry's oligopolistic structure and favorable demand trends once widespread travel resumes.

Patience isn't always a virtue. The managers have been burned by sticking with companies that went bankrupt. To keep that from happening again, they are stress-testing the balance sheets of current holdings and will not hesitate to make a sale if solvency is an issue.

Over the long haul, investors have benefited from the managers' very low turnover approach. Granted, the fund's recent struggles caused its 15-plus-year since-inception record through June 2020 to lag the Russell 3000 Growth Index. The fund, though, remained ahead of most peers, and its subadvised elder sibling Vanguard Primecap VPMCX has a benchmark-beating record dating to the 1980s.

Process | High The fund earns a High Process 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 a fundamentals-based, benchmark-agnostic approach that 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, 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 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 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 POSKX focus on firms with better-than-anticipated results ahead, mispriced assets, or turnaround potential.

People | High Primecap Management's five managers and 14 equity analysts are among the industry's most talented. The team is stable and includes a healthy mix of seasoned and more-junior members. Its managers invest substantially alongside shareholders. The fund earns a High People 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 co-founder Kolokotrones is the veteran of the group, with 50 years of industry experience, and Marchetti is 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 an area of expertise. The analysts' industry experience ranges from one year to more than 15, with many having spent most of their investment career at Primecap. The firm typically recruits standouts from top business schools, but it does make experienced hires, such as the August 2019 addition of biotech analyst John Scotti.

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 | High Pasadena, California-based Primecap Management is an excellent equity shop and merits a High Parent rating.

The firm has ties to two other industry standouts. Its co-founders worked at Capital Group prior to striking out on their own in 1983, and they brought with them a multimanager approach to running money. Early on, Primecap also forged a subadvisory relationship with The Vanguard Group that remains important. At year-end 2019, roughly two thirds of Primecap's $147 billion in assets under management were in its three Vanguard strategies, with most of the rest in Primecap's three Odyssey-branded funds.

Primecap sticks to what it does best. Its five managers and analyst team are focused on a growth-oriented approach to equity investing that can still be very contrarian. The firm is capacity-conscious, as four of its six U.S. open-end funds are now closed to new investors, and it has resisted broadening its lineup by adding non-U.S. stock strategies or bond funds.

Its investment talent shows no signs of letting up. New analyst recruits have excelled in rigorous academic fields prior to attending a top business school or have proved themselves in the industry. They have wide latitude to find their own way but must meet high standards. Voluntary analyst departures are rare; the most recent occurred in October 2019 when Internet and software analyst Stephen Klein left the firm.

Price It's critical to evaluate expenses, as they come directly out of returns. The share class on this report levies a fee that ranks in its category's cheapest quintile. Based on our assessment of the fund's People, Process, and Parent Pillars in the context of these fees, we think this share class will be able to deliver positive alpha relative to the category benchmark index, explaining its Analyst Rating of Gold.

Performance This fund's long-term record is still superior to most of its large-growth category peers, but recent struggles have caused it to fall behind the Russell 3000 Growth Index. Since its late 2004 inception, the fund's 10.6% annualized gain through June 2020 beat the category norm by 126 basis points but trailed the index by 46 basis points with above-average volatility.

With its aggressive profile, the fund has thrived in most market rallies, including 2009, 2013, and 2017. Its best year of performance relative to the index was 2005, when 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. They did the same after Biogen's March 2019 plummet, as they still like Biogen over the long haul.

The fund has consistently struggled in market downturns, including the 2007-09 financial crisis, 2011's turbulence, and early 2020's bear market. Airline picks were the biggest culprits in the recent underperformance, including top-15 positions in United Airlines UAL and Southwest Airlines entering 2020. United shares lost nearly two thirds of their value in the first quarter and Southwest shares a third.

Portfolio This fund's roughly 140- to 160-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-20 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 2020, Primecap's firmwide stake in construction and engineering firm Aecom ACM, a top-15 position in this fund, was near 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 50% of assets since mid-2005, 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 overweighting 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 2020, this fund had a combined 38.4% stake in small- and mid-cap stocks, versus 12.4% for Vanguard Primecap. Both funds, though, are in the large-growth category.

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