When Mani Govil, took over as the manager of the $899 million ( GPAFX) RS Core Equity Fund (GPAFX) two years ago, he hit the ground running.For the previous 10 years, the fund's long-suffering shareholders had watched their investment decline by a cumulative 8%. Meanwhile, the overall stock market, as represented by the S&P 500, had rocketed 120%. But since Govil's arrival on Aug. 1, 2005, RS Core Equity has joined the elite ranks of active managed funds outperforming the stock market. It has surged a cumulative 38%, compared with 24.7% for the S&P 500. So far this year, the fund is up 16.3%, or nearly double the 8.5% gain in the S&P. The secret to Govil's success? He describes RS Core Equity's portfolio as a pyramid. The bottom level, the fund's foundation, is made up of companies he calls "toll keepers," which have the biggest weightings. These are companies with a sustained competitive advantage in their markets. Whether the economy is hot or cold or the market is value driven or growth driven, so long as these toll keepers retain this position, their earnings perform consistently well, Govil cites Mastercard ( MA) as an example. "Any time a person uses the card, whether they pay it off or not, just by virtue of their using the card, they pay a toll to the company," he says. "It's a difficult business to penetrate and collectively they own the customer."
Boeing ( BA), another toll keeper, is one of the fund's best holdings, says Govil. He likes the fact that only two companies make planes with more than 100 seats, Boeing and Europe's Airbus. The Chicago-based aircraft builder has taken a significant lead over Airbus, says Govil, as it has a backlog of 700 planes in its 787 program, which could give it a three- to four-year lead on its rival. Govil also likes James McNerney, Boeing's chief executive. As the former CEO at 3M ( MMM), he has a proven record of increasing profitability. McNerney has also headed the aircraft unit of General Electric ( GE), where he increased cash flow and margins. "We think he's following a similar program at Boeing," the fund manager says. In the middle of Govil's pyramid, with relatively moderate weightings, are companies he calls "superior executers." These companies don't necessarily have a competitive advantage in their markets, but what they do, they do very well. The fund manager points to the market's recent downturn amid the subprime mortgage crisis; many investment banks that were overexposed to bad mortgage loans have taken a beating after a slew of earnings misses. But Goldman Sachs' ( GS) earnings nearly doubled for the quarter ended Aug. 31 and revenues surged 63%. "When the tide goes low, that is when you see who is swimming naked," says Govil. "During a slow time, Goldman came out fine."
Wells Fargo ( WFC) also lands on his good-execution screen with five years of better-than-average returns. Finally, at the top of the pyramid are a small group of companies that Govil predicts will be the core holdings of tomorrow, such as Internet search engine Google ( GOOG), which currently has more than 50% of its market. "If it
Google's market share goes to 90%, where they mostly own the customer with little chance of the customer leaving," says the fund manager, "then it will become a core company." Other stocks the fund holds include Chubb ( CB). This insurance company is a niche player best known for offering comprehensive policies to homeowners who own a yard. Govil says these customers are more focused on service and are not particularly price-sensitive. He also likes Enterprise Products Partners ( EPD), which transports and processes liquid natural gas. This is a toll keeper with a 6% dividend yield. Govil says he is cautiously optimistic about the broad stock market. And while the economy appears to be slowing, he doesn't see a hard landing. RS Core Equity does have a 4.75% load, or sales commission, but the expense ratio is about a third less than the typical actively managed fund at 0.93%. Its recent performance hasn't been reflected in its rating from Morningstar, which is currently just two stars. The Chicago fund-research house gives the returns of the past 10 years a 50% weighting in its five star rating system. And over that period the Core Equity Fund earned just one star. But for the past three-year's performance it gets three stars.