Cloistered far from Wall Street in Greenwood Village, Colo., the managers of the
Icon Information Technology Fund stand out with an impressive track record amid the wreckage of technology stocks.
Craig Callahan, the lead manager of the fund and the chief investment officer of the fund's adviser, and Robert Straus, assistant portfolio manager, shun such tools as P/E ratios and attending company meetings to choose stocks.
Instead, they rely on a quantitative model to try to identify which of the 12 information technology sectors designated by Standard & Poor's are undervalued. The model compares a stock's price with its intrinsic value, which is calculated using a modified version of an equation first published by value guru Benjamin Graham in 1962. The equation includes average earnings, a forward-looking earnings growth rate, beta and Moody's triple-A bond yield.
It may not be the sexiest way to choose stocks, but the fund has established an enviable track record, ranking among the top 5% in its category over several time periods, including year to date, six months, one year, three years and five years. And it has accomplished that by avoiding household names like
. Recently, the two have focused the fund on software and electronic equipment and instruments names, two sectors that have managed to avoid at least some of the carnage in the tech sector.
While other fund managers and analysts lament that tech stocks are still overpriced, Icon's model shows there are still plenty of bargains to be had. Read on to find out more.
1. Can you explain your model in a little more detail and how it has led to such a strong performance?
Managed since: 2/19/97
1-year return: -28.3%/ Beats 95% of its peers
5-year return:-12.23%/ Beats 95% of its peers
Top holding: Methode Electronics (METHA)
Assets: $200 million
Sources: Morningstar and Icon Funds. Returns through 7/11/02/. Top holding as of 7/09/02.
We believe markets have themes that generally last one to two years. By a theme, I mean certain industries lead the way. Looking back five years, we've been good at avoiding some industries, and tilted towards industries that have performed well.
2. What industries do you like right now?
Currently we're heavily tilted toward software stocks and stocks in the electronic equipment and instruments industry. If you look at what's happened, there really hasn't been any place to hide. It's been a pretty broad downward movement in tech. We didn't want to be heavily weighted in semiconductors, and we've managed to avoid that group, and we certainly didn't want to be in Internet stocks.
3. Can you give some examples?
We've owned a few names in the entertainment software group, for example,
. It's one of our largest holdings, and it's held up real well in a tough environment this year. It's up 11% year to date, and we've owned it for about a year now. We started accumulating it at around $15 when, based on our model, it was extremely cheap and a real bargain.
is another name in the entertainment software group that is fairly heavily weighted in our fund. It hasn't done quite as well as Take-Two, but again relative to the way other stocks have been doing, it's held its own in the year.
Over in the electronic equipment and instruments sector, the name that stands out is
Global Imaging Systems
. That particular name is up 25% year to date. We started accumulating around the $15 to $18 level, and our average price is probably somewhere in the neighborhood of where
the stock is right now.
The other name worth mentioning would be more of a systems software name, and that's
, which is a security software company. We've accumulated that going all the way back to early January 2001, with our average cost right around $31, and it's trading at $34.80 -- that's up almost 4% year to date. Those are the areas primarily that have helped us avoid a significant portion of the downward spiral in tech.
4. When did you start getting out of Internet stocks?
That goes back to Craig's call in early 2000, and even before then. We've never really bought into the Internet craze.
In our valuation equation we need a company to have earnings so we never bought any IPOs, and I can't recall owning any Internet stocks that didn't have earnings. We didn't keep up with the high-flying, high-risk technology funds in 1999, but we still delivered good returns without having to go to the concept companies. In early 2000 we made a heavy shift away from the mainline technology companies, especially the large-cap ones.
5. Morningstar reported in its last analyst report that your fund benefited from a move to smaller mid-cap stocks in the tech sector. Can you talk about that?
I think what has happened is in times of economic uncertainty that we've had the last few years, people have been clinging to the large-cap darlings that they bought in the '90s. By clinging to them, those have still been priced at a premium, and as value investors at Meridian and Icon, we don't pay premiums. We have found all the way down through the
, the Intels, and the Microsofts that they generally have some type of love-affair premium built in.
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Source: Morningstar, YTD Returns as of 7/11/02
6. One name that caught my eye on your top-25 holdings list, according to Morningstar, was Computer Associates (CA) - Get Report, which has been involved in some controversy of late with investigation by the Securities and Exchange Commission and the U.S. Attorney's Office. Can you tell me about that investment?
We no longer own it. We try to ride industry themes, and we screen for quality. We like companies that are high in cash, low in debt and well-managed. If we own a company, and some unique problem hits them, we're inclined to sell. The company just becomes a dancer to its own drummer, and is not likely to participate in the industry theme that we're trying to capture. That was the case with Computer Associates.
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No, it's not. We do have an average position in Microchip in the fund of 2.2%. Right now, our top holding is
. That makes up 4.7% of the fund, and is in the industry group I mentioned before -- electronic equipment and instruments.
That stock is up almost 50% year to date. But it's probably up just a few percent since we purchased it. There is still value in the stock. It's been a strong performer in a relatively strong group in the tech sector. It also has exposure to the auto industry, which, believe it or not, has been one of the stronger industries.
8. Others are saying tech is still expensive, but with only 3% of your holdings in cash, it appears that you are finding bargains. Is that correct?
Yes. We find the sector in general to be about 35% below fair value. We never use P/E ratios, or price-to-book. Those violate some of the fundamentals of finance. We think people that do use them and think the market is too expensive are wrong.
9. What's wrong with using P/E ratios?
If you're going to estimate fair value for any asset you need to have four elements in that equation. You need to have its earnings, a forward growth rate, a measure of risk and interest rates. P/E violates all of those, and so does price-to-book-value.
10. Are there any special issues investors should consider when investing in a quantitative-based fund like yours?
They would have to get used to us not being in touch with a rumor of the day. We don't use any brokerage research. We think it's a plus that we're out of touch with a lot of the Street scuttlebutt. We do that to be disciplined, and to take the emotions out of investing. Right now we think the market is very emotional, and we think this correction is overdone.
We try to insulate ourselves, and that's part of our discipline and the challenge of investing this way: to ride through emotional times when we think the market's wrong and stocks are on sale, and to just have the discipline to stick to what we do.
It's a lot like when you're seasick on a boat. People with experience will tell you don't look at the waves, look at the horizon. So we have to come in here every day looking at the horizon and not the waves.