Meet the Family Q&A With Value Skipper Jerome Heppelmann

Don't be misled by the value moniker. As a money manager for PBHG, a fund family known for its go-go momentum style, Jerome Heppelmann -- manager of the (PBSVX)Small Cap Value, (PBMCX)Mid-Cap Value and (PBFVX)Focused Value funds and co-manager of the (PSSCX)Strategic Small Company fund -- looks more aggressive than some of his value counterparts.

PBHG Funds' Value Skipper Jerome Heppelmann

He's not a stickler for rock-bottom prices, nor is he averse to tech, the biggest sector represented in the Small Cap and Focused funds. While many value funds tend to have lower than average turnover, Heppelmann estimates typical turnover for his funds at about 150% a year.

"What I don't want to provide is a concentrated fund in slow-growing, stodgy high-yield investments," explains Heppelmann. "I want to capture as much upside as I can during bull markets, but give them a cushion in bear markets."

His funds have all had great runs recently, posting gains in the double digits. The leader of the bunch, Small Cap Value, is up 19% year-to-date. Heppelmann says he was helped along by some prescient buys in energy and financials last spring, though he's trimmed holdings in both sectors since then.

A caveat: Heppelmann has been on the job a short time, only about a year and a half. Before that, he spent three years as a value analyst for PBHG.

TSC: How do you pick your stocks?

Heppelmann: We aren't as cut-and-dried as most value investors. We don't just go looking for the cheapest possible stocks, and hoping they'll return to the mean. We look for a balance between long-term growth, near-term business dynamics, and the valuation you need to pay. But [we don't focus on] the P/E range; it's not that a stock has to be under 20 times earnings.

TSC: What do you mean by near-term business dynamics?

Heppelmann: It could be as simple as a stock buyback, or it could be positive earnings surprises, estimate revisions upwards, a new product cycle or the strength of underlying customers. So all those issues, whether they're positive or negative, doesn't determine whether we buy. But if it's negative, we would demand a much cheaper valuation.

We want to own a little of everything. You're never going to see me hugely overweighted in very slow-growth companies without a lot of things going on as far as change, like REITs or utilities.

TSC: With the market down so much, do you see lots of good potential buys?

Heppelmann: Clearly, more and more stocks are coming onto our radar screen in terms of valuation. But on the flip side, [some of those stocks] are companies with customers in weak financial positions. Inventory buildup could be an issue as well.

TSC: Where are you right now in terms of a tech weighting?

Heppelmann: As of late, Mid-Cap owned less of a percentage of tech than the mid-cap benchmark because most of the quality mid-cap tech-related companies I thought were very, very expensive. So I just refrained from owning them. A lot of the tech companies that I did own I made a lot of money on and sold and they continued to go up.

But in small-cap, the tech weighting is closer to the broader benchmark. Small-caps always have good small ideas that I think are worth the price they're selling for. And there are so many more companies in that range.

TSC: Your funds were overweight energy earlier this year. What did you see there?

Heppelmann: Energy was a pretty big theme for me in all of the portfolios through at least summer this year. About 18 months ago in the energy sector, we saw really a best-case scenario. The near-term dynamics were positive, in the sense that supply levels of natural gas were significantly lower than the five-years average, and we were coming off three of the four warmest winters on record. At the same time, we continue to need more and more electricity, and natural gas is the fuel of choice for power plants. At the same time, the valuation of almost all the companies in the sector were at almost an all-time low. Typically exploration and production companies trace between four and nine times enterprise value to EBITDA , and they were trading at the low end of that range.

TSC: What are some energy companies you've made money on?

Heppelmann: Devon Energy (DVN), EOG Resources (EOG) and Kinder Morgan (KMI), although we have been very much lightening [since gas has gone up in price].

TSC: What are some sectors and companies you like now?

Heppelmann: We like some of the reinsurance names. Reinsurance is when insurance companies sub out some of their risk. Across insurance the pricing's firming, finally, and we're getting some sharp snapbacks. We like XL Capital(XL). One name we're particularly interested in today is Safeco (SAFC). It's significantly off its highs -- from a high of $55 or $60 a couple of years ago to $28 today. It has over a 5% yield and a great valuation.

I still like some of the cable companies, like Comcast (CMCSK)and Adelphia (ADLAC). Satellites haven't taken over the world, like people thought they would. And the cable companies have very steady cash flows. They're somewhat recession resistant. One of the last things people will cancel [in a recession] is cable, because they'll be staying home more often.

I'm a big believer in H&R Block (HRB) for the long-term, though I've been wrong for a long time. It clearly hasn't been the best operational company over the last couple of years. It's a company that loses money three out of four quarters. But it has a great yield, 3.3%, and good visibility going into the tax season. And it's a cheap stock, at 10 times cash earnings per share. My theory is that regardless of which president we get into office, they've both talked about more than a handful of tax credits. That will help H&R Block's revenue. You can talk about the flat tax till you're blue in the face, but the tax code is never going to get easier. H&R Block is a top holding in the Focus and the Mid-Cap as well.

TSC: Your value funds have had really high turnover [according to Morningstar, turnover was 353% for Small Cap Value; 743% for Mid-Cap Value; and 853% for Focused Value]. Why is that?

Heppelmann: Those numbers reflect when we were a very small fund, about $10 million [in assets]. Because I like to stay close to fully invested, any funds flowing in or out caused me to have to sell stocks that day. But my gut says turnover is around 150% right now. That's more normal. And we're focused on after-tax return. Ray McCaffrey and I are both big investors in our own funds.

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