Janus Fund Sheds Sluggish Image and Soars

Since relaxing valuation standards for the stocks he holds, Janus' Jim Craig has seen his returns jump.
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The

(JANSX)

Janus fund is jumping.

The $25.6 billion flagship of Denver-based

Janus Capital

sizzled in 1998 -- ending the year up 38.9% compared with the

S&P 500's

28.6% return. It was the first time since 1993 that the diversified big-cap fund beat the benchmark.

Once a slow-and-steady caterpillar with a conservative bent, longtime manager Jim Craig has gradually transformed the fund into a soaring butterfly with a racier edge. The difference represents a clear shift in investment strategy for Craig, who has managed the 29-year-old fund since 1986.

"I relaxed my sell discipline," he says. "I look more at changes in return on invested capital vs. a straight price-to-earnings valuation. If the return on invested capital is increasing, I don't sell."

In short, Craig abandoned his prejudice against high-priced stocks. "It allows me to hold companies like

Cisco

(CSCO) - Get Report

where the multiples are expanding," says Craig, adding, "Who am I to say what a multiple should be?"

Naturally, the greater rewards of Craig's new approach come with higher risk.

Morningstar

, the Chicago-based fund research firm, says the fund's three-year risk measure is 0.82, up from 0.58 in mid-1996, though it's still relatively conservative compared with the growth-fund norm of 1.0. The Morningstar measure is calculated every month according to a portfolio's downside volatility.

Sheldon Jacobs, editor of the

No Load Fund Investor

newsletter, says he's not worried about Janus' higher risk. "Everybody's risk profile is up," he says. "There's no reason to think his is up any more than anybody else's."

"It's a winning strategy," Jacobs adds. "To me that's what counts."

The same strategy has worked well for the rest of Janus' funds. Last year, the fund firm attracted $11.6 billion in new money as eight of its 12 stock mutual funds slam-dunked the S&P 500, according to

Lipper

. If not for Craig's change of heart, chances are the Janus fund would not be among them.

To be sure, Craig didn't embrace high-priced stocks overnight. It wasn't until the Janus fund suffered a particularly sluggish six months against the S&P 500 from October 1996 to April 1997 that the seasoned manager began to rethink his stock-picking philosophy. As the bull market's cash-flow bonanza pushed multiples ever higher, Craig wrote in Janus fund's April 1997 semiannual report:

Old valuation standards appear to be falling by the wayside, and frankly, as a traditional business analyst, I am having to adjust to the new, high P/E environment. Using strict valuation rules caused me to sell positions too early in some cases and not to invest quickly enough in others. Perhaps we really are in a new equity environment and the business of stock picking has changed a bit.

Over the next six months, Craig's new attitude regarding higher multiples began to show in the portfolio's makeup as technology crept into the fund's top five industries. By the end of October, computer software was the fourth-largest industry weighting at 6.4% of assets, up from a mere 0.1% six months before.

The revamped fund's performance against its benchmark began to improve considerably. After lagging the S&P 500 by almost 8 percentage points from October 1996 through April 1997, the fund matched the benchmark's 17.4% return from April through October 1997. By 1998, the fund's top holdings were among the highest flyers in the market, and the fund soared.

These days, Craig is holding on to his stocks longer, and that appeals to Ed Foster, director of research at

Fabian Investment Resources

, which tracks mutual funds and advises clients on which to buy. "The turnover rate on the fund has gone down, so the taxable gain for shareholders has dropped," says Foster. "I actually think he's doing a better service for his shareholders,"

Going forward, Craig says he sees no reason to rethink his policy regarding higher multiples. "All the arguments before are still in place," he says of the market's liquidity, low interest rates and inflation-free economy.

While the manager is still banking on past winners like Cisco to bring home the bacon this year, he also says he's not expecting the same stratospheric rises in the stock's price. "I do expect very strong earnings growth of 30%-plus, and the stock should appreciate in line with that or hopefully better," he says.

Instead, Craig says he's hoping some of the portfolio's other stocks will take the place of last year's outperformers. "In order to get those kinds of returns, I have to have stocks that have expanding

price-to-earnings multiples as well as strong earnings growth," says Craig.

This year, he is looking for big moves in semiconductor issues

Linear Technology

(LLTC)

and

Maxim

(MXIM) - Get Report

. "They've been through the inventory cycle and the stocks have started to move, but the multiples are still compressed quite dramatically from their historic levels," says Craig.

He also likes the recently merged health-care-services company

McKesson HBOC

(MCK) - Get Report

. Craig says he sees "positive things" in the firm's third-quarter earnings report, despite others' concerns that sales growth at HBOC was not up to snuff. "McKesson is selling off now," says Craig. "But I think the stock is under a cloud and will be a strong performer in the next six months."

Newcourt Credit

(NCT)

is another favorite play right now. The financial services company securitizes leases between companies like

Dell

(DELL) - Get Report

and

Lucent

(LU)

and their customers, then sells the pooled leases to insurance companies. "Insurance companies have a huge need for product," says Craig. "And since they are limited to how much real estate they can invest in, there's big demand for securitized pools."

The diversified fund manager is also betting on a profitable marriage between two radio and TV station owners. "I'm hoping for a merger between

Clear Channel

(CCU) - Get Report

and

Chancellor

(AMFM)

," says Craig. "It will create a powerhouse in the advertising space." He owns both companies.

Craig also is banking on plenty of action in cable stocks -- a favorite sector since 1997. He believes cable companies represent the straightest path into the home for a wide variety of media. "

AT&T

(T) - Get Report

is not going to stop with the 15 million households it got from TCI," says Craig. "There's going to be some fireworks."

To underscore his enthusiasm for the entire sector, Craig exclaims, "I just own all the cable companies up the wazoo." At the end of November, the sector accounted for 11.6% of the fund.

As for the volatile Internet stocks, Craig says, "There's a new business being formed whose upside we cannot gauge."

"It is ridiculous for me to tell you what an

eBay

(EBAY) - Get Report

or

Amazon.com

(AMZN) - Get Report

is worth because I simply do not know. It is speculative and therefore should be consumed in moderate amounts by funds that are more aggressive than Janus," says Craig.

For his own fund, Craig draws the line at

America Online

(AOL)

and leaves the rest of the Internet plays for Janus managers who run funds with more aggressive charters.