Looking for a large-cap growth fund with the tax efficiency that rivals an
index fund but isn't overly concentrated -- read overly exposed -- to the biggest 10 or 20 companies in the index? Duncan Richardson has just the fund for you.
Richardson is the long-time skipper of the Eaton Vance Tax-Managed Growth fund. The fund has been an astonishing success on all fronts. Its 10.23% average annual return over the past 10 years puts it in the top 6% of all large-growth funds, according to Morningstar. Richardson has managed those higher returns with lower risks, thanks to a diversified portfolio of more than 600 companies, none of them making up more than 2% of the fund. The fund is also a winner on the other side of the equation: taxes. A recent Lipper study found that investors lose as much as 25 cents of every dollar of their annual returns to Uncle Sam -- as Richardson says, "We think you should keep the quarter."
In this week's 10 Questions, Richardson discusses a host of topics, among them: how the fund's conservative approach to growth has meant long-term success. How the war on terror may be with us for the next two decades, but it should keep us away from equities. How this market looks poised to recover. And how certain companies, such as the house that Mickey built, look undervalued.
If you want to learn how Richardson and Eaton Vance have let you keep the quarter while making plenty of extra bucks compared with their peers, read on.
1. What is your philosophy on growth investing, keeping in mind the tax efficiency the fund strives to achieve? And how are you putting it to work these days?
The basic philosophy is growth at a reasonable price
GARP. Valuation plays an important role in investing. With a GARP approach, you are, by definition, aware of the risks of overpaying for growth.
We are very much of the mindset that the job of a manager is risk management. One of the ways you do that is with valuation discipline, which we accomplish at Eaton Vance through our research staff. We have a dozen analysts working with us with an average of 17 years in the business.
We go to additional lengths to avoid unnecessary risk by avoiding overexposure to a particular stock or particular sector. That's generally been a good philosophy to have -- year in, year our, war periods, recessionary periods. Diversification has paid off. There are brief periods when it makes more sense to be very concentrated; we just went through one of those in the late 1990s. You had to adopt a concentrated philosophy and own the largest names in the S&P 500 -- that was the path to outperforming the index. Not surprising, during that period, our fund underperformed the market.
Before and after that period, we have managed to outperform enough that the fund has beaten the S&P 500 by several-hundred basis points
the Eaton Vance Tax-Managed Growth fund ranks in the top 6% of its large-cap growth peers.
What sets the fund apart is that we have achieved that outperformance with a lower risk profile from our peers -- even lower than the market itself. The top 10 holdings have constituted about 15% to 20% of the portfolio. The top 10 stocks in the S&P 500 range from low 20s to as high as mid-30%. The fund's portfolio also has a lower beta and a lower standard deviation than the market. That's a pretty nice equation: higher returns, lower risk.
The final element of risk management in the fund is tax management. I don't know if you saw that Lipper study that came out in the past week or so: "Taxes in the Mutual Fund Industry." It's almost as if we wrote this study. (Laughs.) The findings are interesting, confirming earlier studies that shareholders are giving up over 25% of their returns. I like to demonstrate the benefits of tax management by holding up a quarter -- that's what you lose out of every dollar. We try to manage a fund that lets you keep the quarter. It's weird, I was just estimating, and that's exactly what the Lipper study showed! (Laughs.) We talk about keeping the quarter -- that's a pretty big deal, and it's an even bigger deal in a low-return environment.
It's funny to me that people talk now about the benefits of a fund that has losses. The only way it's a benefit is if you have a fund manager who knows enough to take advantage of them and capture them so they can stay tax-efficient down the road. The reality is lots of managers don't have the systems of don't have the motivation to achieve a solid after-tax return. Of course, the Tax-Managed Growth fund does have a mission of maximizing after-tax returns with a reasonable risk profile.
That certainly shows up in your expense ratio. It's 0.47%, that's almost index-fund territory.
Yeah, we're a Lipper Leader for expenses and for tax-efficiency as well.
We actually find lots of folks like the fund for the pretax returns and risk profile that it offers. Controlling the amount investors pay over to Uncle Sam is kind of the icing on the cake for shareholders.
2. The war is over, but geopolitical risks still hang over this market. How do you factor them into your investment strategy?
That's on everyone's mind. Here's where I come down on the effect of war and geopolitical factors on the market. In this day and age, the good and the bad news -- and for war it's mostly bad because it's an ugly thing -- reaches us immediately. It's such an unusual war. I don't know if it was shortened by that fact, but certainly the development of technological weaponry accelerated the war and minimized the casualties. Viewing the war in real-time would lend itself to a shorter conflict because the general population probably couldn't stand the strain of the war.
We have this immediate access to news around the world, whether it be the SARS outbreak, further disruption in the Middle East, terrorist events anywhere in the world -- we'll all know about them and right away. To that extent, these events get pretty quickly incorporated into market prices. That's going to continue to happen.
And the reality of the world that we're faced with -- and it may not be the world that we'd like it to be -- is a semi-permanent backdrop to the war on terrorism for the next two decades. So, for the investment horizon of everyone who reads
, this is it and we're going to have to learn to live with it. (Laughs.)
But that's not such a bad thing. My nightmare scenario is that people are transfixed by it and so scared away from the equity market that they don't participate in it. They don't recognize that crises -- like wars, financial events, bankruptcies, shock to the systems -- tend to set market lows, not make market highs. We had a lot of crises colliding recently -- crises of confidence, accounting, corporate America, a bit of a crisis about the U.S. and its role in the world. It's all a part of the market over the last nine months.
If we're trying to think of the longer term, I think a lot of the elements that tend to be associated with market bottoms we have seen over the past nine months. We've seen redemptions from equity mutual funds bond funds -- the sentiment indicators are telling you that people are scared. And that's a good time to buy. People are fleeing equity funds to the perceived safety of bond funds. We've seen the stabilization of prices -- stocks have stopped going down on bad news. I think what we've seen from this earnings season has been positive.
There's also been a conservatism that has crept into the business environment -- well, not crept, it more came in like a freight train! (Laughs). Corporations now are loath to say anything overly aggressive that they can't deliver upon -- as is Wall Street, because they're getting beaten up for perceived misdeeds. So, what we have is a situation where corporations and people who follow corporations are likely to underestimate companies' ability to deliver earnings.
Looping back to the effect of geopolitical matters on our economy, you have the sentiment effect, which I think gets reflected in the price. But there's also the very real effect on the economy. People are so distressed about what's going on that they stop shopping. And CEOs are so distressed over uncertainty about future plans that they stop spending. That's a very real effect that could depress economic growth and send us back into a double-dip recession. But we don't think that's going to happen.
What we see, fundamentally, is a stabilization of businesses. A good example is
the fund's No. 3 holding reporting recently that business is basically stabilizing. It's not getting better, but it's not getting worse. That's good! In order to get better, things have got to stop getting worse. And we hear a lot of that.
I mean, are we waiting for a bell to go off? Are we waiting to confirm that Saddam's dead or that we get Osama bin Laden? Would it take something like that? I don't know, maybe not. I think continued progress overseas will help people's confidence. The market itself going up will help people's confidence.
We believe, and this is reflected in our fund's positions, that the economy's fine. Earnings will be better than expected.
3. What does this mean for large-cap growth stocks?
Out of a downturn in the economy, large-cap growth stocks tend to do quite well. Over the last few years, the game has evened out a bit. The valuation premiums that growth was accorded in the late 1990s have shrunk. It's more along their historical relation to value stocks. Actually, in some cases, you have this movement of growth stocks into the value camp, evident in the Russell 1000 indices.
The other day, one of our portfolio analysts looked this up for me. There's a Russell 1000 growth and a Russell 1000 value, and there's a subset that's in both. And it's something like 331 companies in both camps. It's enormous. That tells you that you're getting a squashing down of valuations of growth stocks, which has led to wonderful shopping opportunities for long-term investors like us. We've been using the short-term volatility of the market to accumulate good growth franchises for very reasonable prices, we think. We haven't seen these prices for years. There's a lot to like.
There's uncertainty still in the market and a lot of volatility, but it has the feel to us of a market that wants to go up. We think the fundamentals will start to support that later in the year. But you can't wait for the proof. You're never going to get the proof and the price at the same time. You have to anticipate.
Actually, in Eaton Vance's asset allocation fund, we are going to start shifting at the end of this month. We had skewed slightly toward value when we started a year ago. We're taking 5% out of the value side and allocating it to growth. It's more of a signal that we have a bit more confidence in the market and a bit more confidence in the economy. We think growth stocks of all stripes are going to do better in this environment.
4. I've been counseling TheStreet.com readers to diversify away from large-cap growth, primarily because most investors have too much exposure to the category, especially among the big names in the S&P 500, many of which still seem highly valued. Owning a Janus fund, an S&P 500 fund and Fidelity Magellan isn't diversification. Do you think the S&P 500 will perform well?
I think you're right. There's also ways of upgrading within large growth, too. (Laughs.)
I do think there's a subset of the large cap growth that will perform very well in the very short term. But they could face some challenges over three to five years. Generally, those are four-letter stocks.
Stocks listed on the Nasdaq and Amex have four-letter tickers.
Seems an apt way to describe the technology sector over the past few years.
It'll be a long time before they shake that stigma. It's still too soon.
5. Actually, looking down your top 25 holding, the only four-letter holdings I see are Microsoft and Amgen. Why are you still shying away from technology?
I had been saying for about three years that
were the only four-or-more-letter stocks I liked. We haven't liked
quite that long.
But we had some pricing on some of the four-letter stocks back in October, when
was under $10. There's a reasonable risk-reward there. It's a little different at $14. You know, we've compressed these big tech stocks, with all these stock splits. A lot of these big-cat stocks turned up in single digits. (Laughs.) It used to be you never bought a stock in the single digits because once it went that low, it wasn't coming back.
I'm just eyeballing an old list of the top 50 stocks in the Nasdaq. It looks like about half of them are trading under $10 now. Some of them you can't even find anymore:
There's likely to be a boost in some of these stocks like Cisco, because a lot of people who are participating in the day-to-day market movements -- very short-term oriented. A lot of traders and folks on Wall Street tell me that about 50% of the activity in the market comes from these program traders.
6. How does that affect your work as a long-term-oriented manager? Some fund managers have acknowledged that they got lured in to this sort of trader mentality, to a detrimental effect.
I view it as just the opposite. We are different in many ways. We try to take the role of investor, not trader, and use the short-term volatility to our advantage.
You're only worried about the participation of real momentum buyers if you need immediate liquidity to execute your investment style. Think about it. If you're in a concentrated position, you need immediate liquidity. (Laughs.) You can't have a high cost of execution and outperform. If you're choosing to trade a lot, you need a low cost of execution and you need liquidity. So for those types of approaches, this market must be terrifying.
But if you don't need immediate liquidity because you're building positions over weeks and months and exiting over weeks and months and tend to be buying in a slightly contrarian sense -- that short-term bad news will resolve itself -- and you're selling into the inevitable faddishness of groups. We've seen group rotation speeding up -- it's like a carnival ride. We're not trying to trade that rotation, but on the margin, we're trying to buy and sell better.
It's certainly a fascinating time. And I think it's going to stay like this for a while. Some of the real go-go money is going to burn itself out. Certain hedge-fund structures are set up that their managers are going to get rich quick or die trying. The asymmetry of the payoff for those guys is such that there's no incentive to be boring. (Laughs.) So they're going to go for it. And that's distracting and somewhat dangerous for short-term players, or non-diversified players.
We're hopeful that the broader, diversified approach that we offer will give investors a more stable ride -- so they can stay onboard without getting seasick.
7. Some participants envision a range-bound market for a multiyear period, with the S&P 500 in a band of, say, 800 to 1100. In other words, it's 1966-1982 all over again, and we're in 1968 or 1969. Some folks are rolling out fund offerings that try to take advantage of the ups and down with quantitative, program-trading strategies. What do you make of this assessment of the market, and these offerings?
Some of the elements of the market are very similar to what investors faced in the 1970s, after the Nifty Fifty bubble. I think we have to recognize that we are in a postbubble environment. There may be more "bubble trouble" in some balance sheets still left to come out. We're still in the shadow of the peak -- it's not that far away. You can draw it on a chart; it still looms pretty large over your shoulder.
That said, I would disagree that the right strategy is to become trading oriented. Again, you have to at least a three-year time commitment to the market; five is better. If you can invest with that in mind, in a way that you can survive the kind of volatility, you have the advantage of staying in the game. The guys that are coming out to try to essentially try to not only time the market, but essentially subsectors of the market, are unlikely to be successful. There are some people who are good at timing the market, but they come along once in a blue moon. The reality is most people just aren't very good at that.
The critical decision to make for investors is whether or not you want exposure to the market. If the answer is yes, then you have to choose what kind of exposure you want. Most people underestimate their tolerance for risk; that's too bad. You look around at various asset classes -- what are your alternatives? They don't look very appealing.
You're looking at 10-year bond yields less than 4%. That may be fine for a year, but beyond that, you better look to hold to maturity. I sit back and look at the flows out of equities into bonds. While it may not be at extremes, it looks pretty close. Extreme moves are always wrong -- historically, anyway. When you have kids my kids' age, you're not sending them to college on the return you get from bonds!
What's the asset class that over five to 10 years offers the prospect of delivering high single-digit returns? Equities, as it always has been. In or out of the market? I say in. But because of the volatility we're going through, which may persist, it's not an environment where you want to throw caution to the wind. Conservative, diversified strategies are probably the way to go.
Also, dollar-cost averaging! We've been advising our clients on the virtues of those regular investments. What dollar-cost averaging allows you to do is save you from yourself.
8. You have more than 600 holdings in the fund. The top 10 holdings make up about 15%. Among your bigger companies, is there one you feel so confident about that you say, I wish I could have a bigger chunk of the fund in that stock?
I've chosen not to win that way, if you will -- take unnecessary risks on one stock. Not that I wouldn't let the positions grow. But there's no need to make that concentrated bet.
Actually, the way the portfolio best works is that most of the top 10 have found their way there by earning their way there. I tend to buy up to just below the top 20 in a less-than-1% position. I'm trying to accumulate stocks that I believe can double in absolute price over a five-year period. So, you don't always find that, but we're finding it more and more. I tend to build those up, and then stop buying them and let the stock and the earnings do the work.
The drivers of the fund turn up the top 10 holdings. The next drivers are most likely in the next couple of tranches. That's the basic approach, and that's why we tend to not talk about individual stocks. It's literally dozens of stocks that drive performance. And the key to the tax-efficiency of the funds is, the ones that don't work out, we are pretty unemotional because we haven't lost that much. If you have a 1% position that falls 10%. It's down 10 basis points. Look, I can sit on the sidelines for 30 days. If you're patient about that initial entry point, it allows you to be so much more tolerant about the volatility. It lets you build the position when everyone else is getting out of it.
9. Any stocks you can mention where your building positions against the grain now?
We're building up
, down around the $15 level. We've been doing this for two years now. (Laughs.) But we think this can be a $30 stock in a few years' time.
Obviously, some cyclical things are working against it. A lot of that is being priced into the stock. The stock has been between $15 and mid-$20s over the past few years; we're buyers at these levels.
It's interesting that you're building up Disney. It seems to me that the five or six big media stocks tend to Indian Run: One lags, like Disney, for a while, then surges to the front. Viacom was a laggard a few years back.
That's a great concept. (Laughs.) That was always the way you bet on the networks. You always bought the network that had the worst ratings because it will eventually turn around. The Indian running may say more about the market than fundamentals with the media companies.
In a lot of industries, you are seeing more disparate behavior of the companies within the sectors. That's why you need good stock-picking.
Speaking more broadly to sectors rather than individual companies, we don't see any true leadership emerging yet. So we're just going to have to be patient.
10. You mentioned earlier about the four-letter stocks. A lot of those companies, former highlighers, got the real juice off the October lows and this year, too. Not just the Nortels at a buck-fifty, but also the eBays and Yahoo!s. Is this sustainable?
It's a high-beta, low-quality bounce.
That doesn't play to our strengths, by any means. But we've had periods like this before. They tend to burn themselves out. In the end, valuation does matter. Not to say there won't be good technology investments over the next three to five years, but you have to be more selective. And some of the bubble premium that got into these stocks -- an index premium, if you will -- as you had lots of individuals not paying any attention to valuations or fundamentals. They were just buying companies because they were big. That still probably has to work itself off a little bit. And that's not exclusive to Nasdaq stocks; that's true of some "old economy" blue-chips, too. We're cautious.
While we're always structurally underweight the biggest names because I don't buy up to 3% or more positions. We still have a number of those in the S&P 500.
We don't see great sector leadership. We're slightly underweight tech, slightly overweight industrials, which would include the defense stocks. They've had a pullback, but we're constructive longer term on those companies. But what tends to happen is we look for ideas across all industries, and we find ourselves with similar sector weightings as the S&P 500.
Everyone's fishing in the same pond, if you're large-cap growth investor, you really have to make better judgments about the quality of the company compared to the next guy. Certainly, you're using investment judgment rather than the straight market-capitalization weighting that an index of ETF is giving you.