10 Questions With Mairs & Power's
Tenure: Co-manager of Growth fund since December 1999; Manager of Balanced fund since July 1992.
Growth's performance: 16.11% 10-year average annual (Top 1%)
Balanced's performance: 10.91% 10-year average annual (Top 6%)
Information: 1-800-304-7404 or Web site
Source: Mairs & Power, Morningstar
co-writer Ethan Coen dubbed "Siberia with family-style restaurants," takes more unfair ribbing than most states.
However, many cynical folks on both coasts overlook the virtues of the Land of Ten-Thousand Lakes: verdant countryside, the hipness of Minneapolis (Prince's hometown), the friendly populace -- and the preponderance of great companies. Garrison Keillor might call it the state "where all the companies are above average."
It just so happens that there is a mutual fund firm whose two funds boast "a heavy representation in stocks of companies headquartered in the Upper Midwest."
Mairs & Power Funds, a smaller fund shop that has been around for about 70 years, has racked up outstanding performance by investing in its own back yard. In this week's 10 Questions, we chatted with longtime skipper Bill Frels to learn more about his firm's investing philosophy.
"We're small, we're owned by the employees, we have no outside investors and no marketing pressures to do certain things at certain times," Frels said. Mairs & Power earns the confidence of its investors: Its two managers and three associates have more than 150 years investing experience in total, its funds keep expenses and taxes low, and returns have been exceptional.
Frels co-manages the
Mairs & Power Growth fund with George Mairs, who plans to retire sometime in the next 12 months. The $1.024 billion no-load fund's three-, five- and 10-year average annual returns -- 8.25%, 9.11% and 16.11%, respectively -- rank in the top 1% of all large-cap growth funds, according to Morningstar. Frels flies solo at the firm's asset-allocation fund, the $55 million no-load
Mairs & Power Balanced fund. That fund's three-, five- and 10-year average annual returns rank in the top 6% of its peers -- 3.8%, 5.46% and 10.91%, respectively.
In our conversation, Frels extolled the virtues of hometown companies such as
and a few lesser-known outfits. He also expressed optimism about the prospects for the U.S. economy.
1. What is the investing philosophy at Mairs & Power?
Put very simply, we want to buy growth and we don't want to pay too much for it.
We just don't like to overpay for growth. Nobody does, of course, but since we're not a momentum player it's especially important for us. We pride ourselves in being long-term investors. We want to buy companies and feel like we're a partner in that investment along with the company.
Also, we are constantly examining our investments and appraising the growth prospects -- not just the earnings growth but the quality of that growth. We also keep an eye on the valuation side.
How does a fund family avoid being a momentum investor in a market full of momentum investors, where valuation gaps on stocks close ever more quickly?
It's a challenge. The fact that information flows so much more quickly now than ever before raises some new challenges. We have to be a little quicker ourselves and monitor movements more closely.
Nonetheless, turnover costs money. Actively moving in and out of stocks triggers higher costs and taxes, and we aim to run tax-efficient funds. We try not to let taxes drive investment decisions, but you have to keep them in mind.
Also, the speed with which information flows sometimes works to our advantage. Many times, not always, you have an overreaction on a particular stock. If you can maintain a proper perspective, you can use overreactions from momentum investors as an opportunity.
2. If anyone ever wanted to invest in Minnesota, your funds would be the right way to go. Would you mind telling our investors why the funds have an Upper Midwest bent?
We consider ourselves fortunate from the standpoint that there are a lot of attractive companies around the Twin Cities, which is where we're based. While the fund has a national charter, we find we have plenty of attractive opportunities right in our own backyard.
Since most of the people at Mairs & Power have grown up in this area, we're familiar with these companies and the people managing the companies. That's helpful when we want to have access to management. You know who to talk to.
Of course, since we've had some success, we have national companies that visit us on a regular basis. Our funds tend to be long-term holders. The companies we own appreciate the fact that we are invested in their businesses for the long haul.
We like to think that our knowledge base on Upper Midwestern companies is a little better than outside investors. We know these companies. That works a little bit more with smaller and mid-cap companies that don't have the visibility and exposure outside this area.
What do you make of the argument that with technology, it doesn't matter if you invest in Microsoft (MSFT) - Get Report in Redmond, Coca-Cola (KO) - Get Report in Atlanta or Nokia (NOK) - Get Report in Finland?
What you say is correct. With computers and everybody networked, it seems like everybody knows what everybody else is doing. To some extent, however, we all suffer a little bit from information overload. I guess by focusing on what we have here in the Upper Midwest, and specifically the Twin Cities, we're able to concentrate our energies.
Would you provide an example of how investing "in your own backyard" gave you a better insight into your holdings?
Well, we added a new company this year to the growth fund called
, which participates in the biotech area. We've been aware of the company and visited management, but we always felt that the stock was too expensive.
Over the past year, the price has come way down and the growth rate has slowed a bit, in part from spending cuts at the National Institute of Health, colleges and drug companies. They are a supplier to those markets. The stock price just got down to a point where we thought, geez, it looks pretty interesting. There's a steady demand for the products they make.
We had the management into our office. We had a field trip to the company and kicked the tires. It just seemed like while the short- to intermediate-term growth outlook was fuzzy, that was being overly discounted in the marketplace.
We started moving in and, lo and behold, the earnings we're better than expected, and you know what happens on Wall Street these days with upside surprises. The stock's up about 50%. It's not that we have any inside information, but we look for factors that are longer term, not just quarter to quarter.
We're willing to be patient, too. More often than not, we're buying companies that are getting beat up because they didn't provide Wall Street with a pleasant surprise or they might have missed earnings for a quarter. Everything is a judgment call, and we've been fortunate about the judgments we have made.
3. What's your forecast for the economy, and how much does that outlook factor in to your investment strategy?
You have to have a framework in which to invest, and have a feel for what the macroeconomic environment is. Here again, we're patient. And we're positive. The economy is going to show a slow, steady recovery. We haven't had a serious recession and we don't expect to have one.
Of course, if you lost your job and can't find another one, it's serious. But by and large, look at the unemployment rate and economic statistics during this past recession relative to the early 1990s or even the early 1980s. We really didn't have a serious recession this time around. Given that, you're not going to get the turnaround and quick recovery that everyone seems to be looking for.
4. How will the Growth fund change when longtime co-skipper George Mairs departs?
George will depart at some point this year or early next. We hope there will be a seamless transition.
Everybody's a little different in how they view companies, but the overriding principles of low turnover, a regional emphasis, valuation sensitivity will remain in place.
5. Speaking of growth, where are you finding it these days? Stocks have gotten a lot more expensive since March.
Obviously, valuations have moved up and stocks aren't as cheap as they were three months ago. We're still finding value. Nonetheless, when we compare what we think the future rate of growth will be compared to current valuations, we still see opportunities.
Valuations are high historically and dividend yields are low, but they are coming up. You have to look at interest rates: If you're up against about 4% on the fixed-income side, that's a pretty easy bogey to beat on the equity side. Economic growth may be a bit slow for the next few years, earnings may be a bit slow. But if interest rates stay where they are or move up a little, you don't need big growth to make the numbers.
6. Let's talk about some stocks. The Growth fund's largest holding is Target, a Minnesota native. Does the company still have room to grow?
Target has been around for a long time; it used to be Dayton-Hudson. It's certainly one of the largest retailers. Compared to
, however, it's still pretty small.
We think they will be able to maintain low double-digit growth rates. It won't grow as fast as it once did, but neither will Wal-Mart. And with a price-to-earnings multiple of 20, it's still a reasonably attractive investment. We're not buying currently, but we still think it represents a good investment.
7. Moving to another Minnesota company, what do you like about Medtronic, your second-largest holding?
Medtronic is a very unique franchise. They have expanded away from being strictly a cardiovascular company. Management is getting involved in other markets -- the spine market, pumps for diabetes. They recognize that they're going to have to move into some other areas of expertise, but I don't see them going too far afield from their basic areas of strength. They will continue to perform well.
8. You mentioned that Target isn't currently on your buy list. What is?
, our No. 3 holding, still seems reasonably attractive to us.
We still feel the company can show double-digit growth and it has a low-double-digit multiple. We think it is an attractive long-term stock.
is a regional bank that operates in the Upper Midwest -- the Chicago suburban market.
They have the potential for continued low-double-digit growth. An 11% to 12% growth rate with a price-to-earnings multiple of 13, you're not paying that much for that, plus it has a dividend yield of about 2.7%.
Another big holding is 3M. How has 3M managed to remake itself into more growth-oriented areas, and what do you make of the company's prospects?
If you look at the second-quarter numbers, I think it's been rather spectacular in what
new CEO Jim McNerney has done in a very short time. The improvement has not only been in terms of improved margins and profitability, but also top-line growth. It's easy to lay off people and shut plants, but to create revenue growth in this economy is impressive.
McNerney has been able to position the company to move into faster growth markets with products to better serve those markets. He came in from
with high expectations attached to him, and to date he has been able to live up to those expectations.
The stock has performed brilliantly relative to the market the past two to three years. 3M is a world company. Fifty-five percent or more of volume comes outside the U.S.
George Mairs likes to emphasize that technology per se is one thing, but a lot of the companies that we invest in aren't tech companies per se. They apply technological innovation into what they are doing and have been able to benefit significantly from it -- the Internet, telecommunications. 3M has always been great in this area. They always spent a significant percentage of sales on research and development; that continues to be the case.
9. The Mairs & Power Balanced fund is an asset-allocation fund. How have you been shifting the stock and bond weightings recently?
The allocation doesn't differ much. Recently, we've moved up the equity side. We're closer to 64%, up from 60%. Typically, it doesn't get much over 65% because it is a balanced fund.
It seems to us that stocks are a lot more attractive than bonds here in this environment.
What sort of bonds are you investing in these days, given the rather tough environment?
We've stayed away from government bonds because we feel they're just too expensive. The fund used to be balanced between agency, government and corporate bonds; now, it's almost all corporate. We've moved down the quality range a little bit toward the mid-investment grade bonds -- the a3 type of corporate.
10. Any final thoughts you would like to share with our readers about Mairs & Power?
One thing that overlays our operation here: We're small, we're owned by the employees, we have no outside investors and no marketing pressures to do certain things at certain times.
That can be a real negative for firms. Go back and see what happened to
during the late 1990s. They had some long-term managers who had performed brilliantly, then underperformed during the bubble. They were let go because they weren't performing. This turned out to be the wrong move at precisely the wrong time.
Here at Mairs & Power, we don't have those kinds of pressures, which enables us to stick to our investing philosophy.