Monday, May 14, 2012

Artisan Value Fund: A Solid Core Portfolio Holding

I had the unique opportunity last week to sit down with one of the managers of the Artisan Value Fund, George Sertl. The management team is comprised of 3 managers, 2 of which have worked together since 1989. They are Scott Satterwhite and James Kieffer. Sertl joined Artisan in 2000 as a part of the U.S. Value team, which also manages the Mid Cap and Small Cap Value Funds, both of which are closed to new investors. While each of the managers brings 20 plus years of experience, none of them is older than their early fifties, meaning they will likely be with Artisan for many years to come.

The Value Fund started in March of 2006. This is the only fund of the 3 they manage which is open to new investors, and one I believe represents a compelling investment opportunity. The fund invests in stocks with a market cap of $2 billion and up. By design, this captures equities in the Mid Cap space as well. This is an important point, as 23% of the fund's holdings are under $10 billion in market cap. I believe this is an important point when comparing to a benchmark such as the Russell 1000, as the lower average market cap would tend to exhibit higher earnings growth potential. However, the fund is true to its value style on a number of metrics, including P/E, Price/Book, Price/Sales (approximately half that of the Russell 1000 Index), and dividend yield (2.41% vs 2.07 for the Russell 1000). While the appropriate benchmark for comparison is the Russell 1000 Value, the long-term earnings growth rate in the portfolio at 11.1%, is actually higher than that of the blended Russell 1000 Index of 10.27%. This is a function of the lower market cap bias, as well as the stock picking methodology of the team.

Compared to its peers, the fund invests in a fewer number of equities (typically 30-40), currently 33. Typically, the largest position it will represent no greater than 5% of the portfolio. For example, the fund recently trimmed its position in Apple, as the stock had doubled since it initially purchased. The managers still consider Apple attractive, but felt it was prudent to lock in profits. Not only did they lock in a large profit, but they were sensitive to tax consequences, waiting an additional week from when they made the decision, resulting in a long term capital gain.

The Value Fund's time horizon is typically 2-5 years when they make a purchase. However, if any holding approaches what they consider to be fair value before then, they will either reduce it or sell the entire position.

Investment Philosophy:

The Value Fund has what they refer to as 3 margin of safety criteria:

1. Attractive Valuation: Look for equities selling at a discount to their estimates of market values. This can mean a discount to book value, discount to normal price/free cash flow, P/E, etc. They are typically companies with low expectations in the marketplace and a favorable risk/reward.
2. Sound Financial Condition: Does the company have financial flexibility, meaning can they borrow at a reasonable rate, buy back stock, etc.
3. Attractive Business Economics: Can the company grow the business, preferably organically. How healthy is free cash flow? Can they buy back stock to enhance shareholder value in a major economic downturn?

The Value Fund doesn't necessarily look for a "catalyst" for the stocks they buy. They believe that pricing itself can take care of that over time. Additionally, they allow 2-5 years for this to happen, as the market tends to be inefficient in this timeframe, and therefore, patience is important in exploiting business value inefficiencies.

The opportunistic nature of Artisan Value can be seen in its overweight of certain sectors. In fact, they do not attempt to closely match the weightings of the various sectors of the benchmark index. As a bottom up manager, Artisan invests in sectors where they see value.

Below is a comparison of the fund holdings to the various Large Cap Russell Indices

Sector Weightings Artisan Value
% Stocks
Russell 1000
Russell 1000
Basic Materials 0.00% 3.31% 1.92% 4.59%
Consumer Cyclical 2.12% 10.66% 8.36% 12.82%
Financial Services 27.22% 13.10% 23.34% 3.22%
Real Estate 2.65% 2.68% 3.74% 1.72%
Communication Services 2.71% 4.28% 5.51% 3.16%
Energy 15.45% 10.67% 11.53% 9.66%
Industrials 4.22% 12.28% 10.32% 14.09%
Technology 29.7% 17.99% 7.73% 27.69%
Consumer Defensive 11.13% 10.51% 8.34% 12.85%
Healthcare 4.79% 11.10% 12.31% 10.16%
Utilities 0.00% 3.41% 6.90% 0.06%

As of 3/31/12
Source: Morningstar

Interestingly, the fund has a strong overweight in financials, with nearly 4% greater than that of the Russell 1000 Value Index. However, its important to note that BNY Mellon is the only bank stock in the top 25 holdings. I believe this is in large part due to the fact that BNY derives a large portion of its earnings in products and services such as asset management, wealth management, and advisory services. One of Bank Of New York’s main competitors in the capital markets industry is Goldman Sachs, which the fund purchased late last year as it approached cash value. They have a large position in property and casualty companies, as they purchased what they consider to be "best of breed" companies which were selling at or near book value. Berkshire Hathaway, for example, is a diversified financial services conglomerate, which also has retail operations, railroads (Burlington Northern), utilities, and energy distributors. Soon after they initiated a position in September 2011, Warren Buffett announced that the company would start a buyback. Three of the top 10 holdings are financials (Berkshire Hathaway, Progressive, and Western Union). Western Union, which is a specialty finance company that provides domestic and international money transfer services.

The fund also has a large overweight to technology companies (4 out of the top 10 holdings), as they have found several companies with great free cash flow, undemanding valuations, and some of the strongest balance sheets around. As you can see in the above table, the technology sector weightings more closely resemble the Russell 1000 Growth Index. Still, they have a 2% higher weighting vs. that index. As previously mentioned, Apple is the largest holding, however, the fund has taken substantial profits and reduced the position. But again, the approach is mainly "bottom-up", meaning a de-emphasis the significance of economic and market cycles, and instead, focusing on the analysis of individual companies. The Technology sector just happens to be where they are currently seeing the most value over the intermediate term.

Artisan Value is the type of fund which will tend to do better in "risk off" markets where investors are nervous and seeking "safer" stocks to purchase. The fund's only notable misstep came in 2008, when it was overexposed to bank stocks. However, it righted the ship in 2009, outperforming its benchmark by a whopping 16%. Last year, it also substantially outperformed by 5%. Because of its opportunistic nature, it also outperformed the Russell 1000 in those years. Lipper ranks it in the top 6% for 1 year performance, 15% in 3 year, and 38% for 5 year. Were it not for the bank bet in 2008, I'm certain it would be in the top quartile for all 3 time periods. This fund is a solid core holding in any portfolio.

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