Hennessy Sticks to System, Beats the Market

Investors reap rewards because, no matter what, this fund family doesn't waver over the long term.
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NEW YORK (TheStreet) -- Hennessy Funds follows an unusual approach. Seeking to outpace the broader stock market, the company employs simple mechanical strategies that are disclosed in fund prospectuses.

Most of the time the funds have accomplished their goals. "Our strategies try to beat the indexes by a bit while recording lower volatility," says Frank Ingarra Jr., a portfolio manager.

The Hennessy funds are based on ideas developed by James P. O'Shaughnessy, author of the bestselling

What Works on Wall Street

(McGraw-Hill, 1996). Examining performance data over four decades, O'Shaughnessy concluded that it was possible to beat the

S&P 500

by following certain rules. For example, stocks with high dividends tended to outdo the index. You could also outperform by owning stocks with low price-to-earnings ratios and growing earnings.

O'Shaughnessy created a fund family that employed his rules. But in the late 1990s, many of his funds lagged as investors ignored the rule books and raced after high-priced Internet stocks with no dividends and earnings.

Neil Hennessy bought the funds and persevered. He understood that the systems would periodically lag. But he argued that investors who followed the systematic approaches would be rewarded over the long term.

To appreciate the Hennessy approach, consider

Hennessy Cornerstone Value

(HFCVX) - Get Report

, which has returned 3.8% annually during the past 10 years, outperforming the S&P 500 by 5.4 percentage points and surpassing 80% of large-value peers. To pick stocks for the portfolio, Hennessy starts with a universe of 10,000 public companies. Then he narrows the field, only taking companies that have above-average market capitalizations, cash flow and sales -- in fact, sales that are 50% bigger than average. Finally, the fund takes the 50 stocks with the highest dividend yields. Hennessy holds the stocks for one year. Then the fund rebalances, again picking the top 50 stocks that show up on the screens.

The resulting portfolio includes big companies with plenty of cash. The high-dividend shares in the fund are generally unloved. This occurs because dividend yields rise when stock prices fall. "Many of the holdings are great companies that could rebound soon," says Ingarra.

Holdings in the fund include

Limited Brands



H.J. Heinz


. Both companies have been improving cash flows by cutting costs and expanding overseas.

Another fund with a solid record is

Hennessy Focus 30


, which returned 2.9% annually during the past five years, beating the S&P 500 by 3.9 percentage points and exceeding 88% of its midblend peers. The fund takes only stocks with market values of $1 billion to $10 billion. The shares must have price-to-sales ratios of less than 1.5. This eliminates expensive names because the fund's stock universe has an average price-to-sales ratio of 3.

In addition, earnings of the stocks must have increased in the past year. The shares must have appreciated in the past six months.

Following the criteria, the fund aims to hold cheap stocks that are on the upswing. Holdings in the fund include

Virgin Media



Del Monte Foods



Hennessy Total Return

(HDOGX) - Get Report

returned 2.8% annually during the past 10 years, outdoing the S&P 500 by 4.5 percentage points. The fund puts 25% of its weighting in fixed income and the rest in the so-called Dogs of the Dow. Promoted by O'Shaughnessy and Michael B. O'Higgins, the Dogs approach calls for buying the 10 stocks in the Dow with the highest dividend yields. Current Dogs include

E.I. DuPont

(DD) - Get Report



(VZ) - Get Report


Although the Dogs won legions of followers in the 1990s, no mutual fund could track the approach exactly because the SEC requires fund portfolio managers to own more than 10 stocks. The closest adherent has been Hennessy Total Return.

Not all the Hennessy funds have been winners.

Hennessy Cornerstone Growth

(HFCGX) - Get Report


Hennessy Balanced

(HBFBX) - Get Report

have lagged most of their peers. But all the Hennessy funds with 10-year records have outpaced the S&P 500 during that time. Their performance demonstrates that it is possible to get decent returns by finding a solid strategy and sticking with it.

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Stan Luxenberg is a freelance writer who specializes in mutual funds and investing. He was formerly executive editor of Individual Investor magazine.