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, 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 ( LTD and H.J. Heinz ( HNZ. Both companies have been improving cash flows by cutting costs and expanding overseas.
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