Our Ultimate Stock-Pickers' Top 10 Buys and Sells
The runup in the markets during the first quarter increased the importance of good old-fashioned stock picking for our top managers; new-money buys help populate top purchases.
By Greggory Warren, CFA | Senior Stock Analyst
After retreating to near-bear-market levels during the third quarter of last year, U.S. stock markets (as exemplified by the S&P 500 Index) rebounded strongly from October 2011 through to the end of March this year, with the double-digit return generated by the S&P 500 during the first quarter of 2012 being the strongest first-quarter showing for the benchmark index in over a decade. Even so, investors continued to shun actively managed U.S. stock funds, pulling close to $25 billion from these funds during the first quarter (on top of the $45 billion that they pulled out during both the third and fourth quarters of last year). This left many managers in the mutual fund industry, including some of our Ultimate Stock-Pickers, facing the prospect of a heightened degree of investor redemptions even as the markets continued to lift the values of their portfolios during the first quarter. We expect that the downturn in the markets since the end of March has only added to the desire of many managers to keep additional cash on hand to meet investor redemptions. It was against this backdrop that our top managers made their portfolio decisions during the first quarter (and early part of the second quarter), with much of the data indicative of managers that continue to be engaged in good old-fashioned stock picking.
As the value of many of the names already in their stock portfolios rose during the first quarter (much as they did during the fourth quarter of last year), there was once again a dearth of buying activity among our Ultimate Stock-Pickers, who had been (up until the fourth quarter of last year) far more focused on putting money to work in stocks that were already in their portfolios as opposed to making a lot of new-money purchases. With buying activity down overall, the new-money purchases that were made during the first quarter stood out a lot more, much as they did during the fourth quarter, with six of the top 10 high-conviction purchases made during the first quarter actually seeing one or more manager putting money to work in new names. As you may recall, we believe that managers make new-money purchases only when they have a high degree of conviction in the shares of the firms that they are buying. That's not to say, though, that managers do not make high-conviction additions to their existing holdings; it's just that we believe it is far easier for them to put money to work in holdings that they are already comfortable with than it is for them to make a bet on a brand-new name.
With regard to the selling activity during the quarter, five of the top 10 sales made during the period involved at least one of our top managers completely eliminating their stake in a company, with several of the high-conviction sales that actually popped up tied to Alleghany (Y), one of the four insurance companies in our Investment Manager Roster, which has been clearing out portions of its own stock portfolio to raise capital for its purchase of Transatlantic Holdings, a top 10 global property and casualty reinsurer that Alleghany had acquired for $3.4 billion. This suggests to us that our top managers continued to trim back positions (in a rising stock market) as opposed to making wholesale moves out of names, with the potential threat of investor outflows likely having a greater impact on the sales activity. The selling activity (as well as some changes made to our Investment Manager Roster ) also had an impact on the top 10 holdings of our Ultimate Stock-Pickers, which saw three names-- ExxonMobil (XOM), Coca-Cola (KO), and Cisco Systems (CSCO)--fall off the list in favor of three stocks-- Google (GOOG), United Parcel Service (UPS), and 3M Company (MMM)--that have hovered just outside of the list of high-conviction holdings for much of the last year.
Changes to the Investment Manager Roster
For those that have been following our work since we relaunched the Ultimate Stock-Pickers concept back in April 2009, you'll recall that one of our main goals was to be far more proactive with the Investment Manager Roster, moving fund managers off the list and replacing them with better-performing peers whenever we felt that such a move was warranted. We believed then, as we do now, that this type of flexibility is necessary for us to work toward our ultimate goal with the roster of top investment managers, which is to build and maintain a list that can consistently generate high-conviction buys and sells from the ongoing transactions of some of the best managers in the business. That said, we prefer to make changes to the Investment Manager Roster only once a year, gathering up data points and other information as we go through each calendar year that help us make more informed decisions. As a general rule, we will only remove a manager from the Investment Manager Roster if: (a) there is a meaningful change of managers for a fund (and we have little confidence that the succeeding management team will be able to replicate the level of performance historically generated by the fund); (b) a fund closes or merges with another fund, and the fund no longer follows the same investment processes or is no longer run by the same management team; (c) the fund is no longer covered by Morningstar's mutual fund analysts; and, (c) the long-term performance of a fund falls meaningfully below benchmark returns.
Looking more closely at the performance hurdles that we examine when assessing the managers on the Investment Manager Roster, we remain committed to focusing on institutional investors that have a proven track record of beating the markets in both good times and bad, which is why we regularly look at the one-, three-, five-, and 10-year relative returns for the fund managers on our list. Given the timing of when we look at these returns, as well as the fact that our managers can go through periods when their style of investing is out of favor, or where they've made bets that are negatively skewing their near-term (and to some degree longer-term) performance, the trigger levels that we've established for relative fund performance act less as elimination mechanisms than they do prompts for us to look more closely at a manager whose performance is trailing the hurdles we've established. In this regard, we rely more heavily on the input we receive from Morningstar's mutual fund analysts, who've always provided us with valuable insight into the investment styles, processes, and other considerations of the fund managers listed on our Investment Manager Roster. We've taken this process one step further this year, though, working much more closely with the mutual fund team to try to incorporate the new Morningstar Analyst Rating for Mutual Funds, which offers a forward-looking analysis of a fund, into our selection process for the Investment Manager Roster. While this remains a work in progress, we feel that the additional layer of insight provided by the Morningstar Analyst Rating for Mutual Funds will help us to stay true to our goal of maintaining a list of top managers that can consistently generate high-conviction buys and sells from the ongoing transactions of some of the best investors in the business.
With regard to the changes we have made this year, Matrix Advisors Value (MAVFX) was removed primarily because it was dropped from coverage by our fund analysts, and Columbia Value & Restructuring (EVRAX) was eliminated because the current manager is retiring at year end and our fund analysts have no established track record on his replacements to discern whether or not the investment process will change once he departs. We've replaced the two outgoing managers with Sequoia (SEQUX) and Diamond Hill Large Cap (DHLAX), respectively. Much like we've done in the past, we've made every effort to replace the outgoing managers with managers that have similar investment characteristics, allowing us to maintain an appropriate level of diversity among the mutual funds in our list of top managers. With value and growth styles typically coming in and out of favor at different times, we feel that having an appropriate mix of managers should allow us to identify higher-conviction buys and sells than we might generate by focusing on just one investment style alone, especially if more than a handful of managers across the spectrum of large-cap funds are actually buying (or selling) the same security at the same time.
For those who may wonder why Sequoia, winner of the Morningstar Domestic-Stock Manager of the Year designation in 2010 (and a leading candidate for the award in 2011), was not already on our list, we actually had it on the Investment Manager Roster for the first year that we were running the Ultimate Stock-Pickers concept, but given the propensity of managers Bob Goldfarb and David Poppe to wait until the very last day of the 60-day SEC filing deadline for their holdings, we were constantly working with stale data from their fund whenever we put together the lists of top 10 buys and sells for our top managers. Attempting to balance the need for timely information with the desire to have some of the best investment managers in the business represented on our Investment Manager Roster, we've had to make decisions in the past that sometimes ran contrary to our goals with the Ultimate Stock-Pickers concept, which was never our intention. As such, we made the decision this year shift our publication cycle so that we can capture late filers like Sequoia into the data that ultimately generates the lists of top 10 buys and sells of our top managers each quarter, even if it means having the data be a little bit less timely than it has been in the past.
Ultimate Stock-Pickers' Top 10 Stock Holdings (by Investment Conviction)
Star Rating Fair Value Uncertainty Moat Size Current Price (USD) Price/Fair Value # of Funds Holding Mcrsft (MSFT) 4 Medium Wide 28.45 0.81 16 J&J (JNJ) 4 Low Wide 61.78 0.80 12 Wal-Mart (WMT) 2 Low Wide 65.55 1.07 14 Wlls Frgo (WFC) 4 Medium Narrow 30.16 0.74 12 P&G (PG) 4 Low Wide 61.55 0.82 11 Brksh Hthwy (BRK.B) 4 Medium Wide 79.02 0.79 9 PepsiCo (PEP) 4 Low Wide 67.51 0.94 11 Google (GOOG) 4 High Wide 570.98 0.73 12 Untd Prcl Svc (UPS) 3 Medium Wide 73.25 0.92 9 3M (MMM) 4 Low Wide 82.85 0.83 10 Data as of 06/01/12. Fund ownership data as of funds' most recent filings.
Unlike previous periods, when we saw few changes in the makeup of the top 10 conviction holdings of our Ultimate Stock-Pickers, the first quarter saw three names--ExxonMobil, Coke, and Cisco--fall off the list in favor of three other stocks--Google, UPS, and 3M--that have hovered just outside of the list of high-conviction holdings for much of the last year. The changes were far more the byproduct of increased buying activity among the three names that made the top 10 holdings this period than anything else, as the combined performance of the three departing names was actually better than the three stocks that moved up in the rankings. That said, ExxonMobil was aided in its departure from the top 10 holdings, as meaningful sales from both Alleghany and Hartford Capital Appreciation (ITHAX), which completely blew out its stake in the energy giant, further reduced its impact on the aggregate holding of our top managers. While Coke and Cisco saw trimming activity by a couple of managers during the quarter, it was the removal of Matrix Advisors Value, which held both securities, and Columbia Value & Restructuring, which held Cisco, from the Investment Manager Roster that had a more profound impact. Coke and Cisco were, however, firmly planted in the 11 and 12 slots, respectively, at the end of the period, while ExxonMobil tumbled much further down the list.
Looking more closely at the promoted names, Google continues to impress us with the amount of attention it has received from our top managers. FPA Crescent's (FPACX) new-money purchase of shares of the search engine giant made it the 12th manager in our list of 26 Ultimate Stock-Pickers to add Google to its holdings. While the bulk of the holdings are split among managers following Large Cap Growth-- Amana Trust Growth (AMAGX), Aston/Montag & Caldwell Growth (MCGIX), Oppenheimer Global (OPPAX), RS Capital Appreciation (RCAPX), Vanguard PRIMECAP (VPMCX)--and Large Cap Blend--FPA Crescent, Hartford Capital Appreciation, Oakmark (OAKMX), Parnassus Equity Income (PRBLX), Sequoia--strategies, it is interesting to note that Mutual Shares (TESIX) , a value-oriented Large Cap manager, and Alleghany, one of the insurance companies on our list of top managers, both owned shares of Google at the end of the most recent period. We also view UPS and 3M as being fairly well represented, with nine of our top managers owning the former name (and two of them making more meaningful additions to their holdings), and 10 of our Ultimate Stock-Pickers maintaining positions in the latter security during the most recent period. It should be noted, though, that 3M benefitted from the inclusion of Diamond Hill Large Cap, which held stakes in Cisco and ExxonMobil as well, to the Investment Manager Roster this time around.
Ultimate Stock-Pickers' Top 10 Stock Purchases (by Investment Conviction)Star Rating Fair Value Uncertainty Moat Size Current Price (USD) Price/Fair Value # of Funds Buying Visa (V) 3 High Wide 112.25 1.07 4 Mcrsft (MSFT) 4 Medium Wide 28.45 0.81 6 Ryl Dtch Shll (RDS.A) 5 Low Narrow 61.16 0.77 3 Sysco (SYY) 4 Medium Wide 27.55 0.77 4 Prkr Hnnfn (PH) 4 Medium Narrow 77.87 0.74 4 Cap One (COF) 4 High Narrow 48.40 0.69 3 Rsrch in Mtn (RIMM) 4 High None 10.26 0.73 1 Disney (DIS) 4 Medium Wide 44.40 0.89 4 Viacom B (VIAB) 3 Medium Narrow 46.26 0.93 4 Lowe's (LOW) 4 Medium Wide 26.36 0.78 1 Data as of 06/01/12. Fund ownership data as of funds' most recent filings.
With Visa (V), Research in Motion (RIMM), Royal Dutch Shell (RDS.A), Parker Hannifin (PH), and Lowe's (LOW) all making our preliminary list of 10 high-conviction buys last week, a list that focuses more heavily on names where we're seeing high-conviction buys (as well as new money purchases) on a manager by manager basis, as opposed to looking at the conviction purchases of all of our managers in aggregate, we've already looked at half of the list of top 10 conviction purchases made by our Ultimate Stock-Pickers during the most recent period. Of these names, Research in Motion sticks out the most to us, if only for the fact that the stock is down close to 35% year to date, with most analysts, including our own Michael Holt, unconvinced that the firm has a credible plan to reverse its declining relevance in the smartphone market. Even so, Prem Watsa at Fairfax Financial Holdings (FRFHF) continues his headlong dive into the struggling Canadian maker of the Blackberry cell phone, picking up another 14 million shares of Research in Motion during the first quarter, making it (at the time), one of its two largest holdings, with RIMM accounting for 19% of Fairfax's total stock portfolio--offset by a 19% portfolio stake Watsa has built up in Johnson & Johnson (JNJ).
Meanwhile, Microsoft (MSFT) stood out to us for the amount of buying activity that was going on, with six of the 16 top managers that held the stock coming into the first quarter purchasing more shares during the period, with Hartford Capital Appreciation having the biggest impact as it more than doubled its stake in the software giant. Sysco (SYY) saw a fair amount of buying activity as well, with four of seven managers owning the stock at the end of 2011 adding to their stakes during the first quarter, with Yacktman (YACKX) making the most meaningful additions, increasing its stake by close to 50% during the period. As for Capital One Financial (COF), the stock may be less widely held, with just three managers-- Dodge & Cox Stock (DODGX), Markel (MKL), and Oakmark--holding shares at the start of the first quarter, but an additional purchase by Markel and Oakmark and a high-conviction new-money purchase by Sound Shore (SSHFX) helped to catapult it onto our list of top 10 purchases during the most recent period.
As for the final two names, Walt Disney (DIS) benefited from purchases by four of our top managers during the first quarter, with a significant addition by Diamond Hill Large Cap to its stake in the entertainment powerhouse being trumped only by a meaningful new-money purchase by Hartford Capital Appreciation. Looking more closely at Viacom (VIAB), a new-money purchase by Berkshire Hathaway (BRK.A) / (BRK.B), a significant increase by Yacktman in its stake, and additional purchases by Hartford Capital Appreciation and Oakmark all combined to lift the stock onto the list of top 10 purchases.
Ultimate Stock-Pickers' Top 10 Stock Sales (by Investment Conviction)Star Rating Fair Value Uncertainty Size of Moat Current Price (USD) Price/Fair Value # of Funds Selling Exxon (XOM) 4 Low Wide 77.92 0.86 2 Dvn Enrgy (DVN) 5 High Narrow 57.99 0.53 3 Wlls Frgo (WFC) 4 Medium Narrow 30.16 0.74 4 Brksh Hthwy (BRK.B) 4 Medium Wide 79.02 0.79 2 Intuit (INTU) UR - - 54.80 - 2 News Corp (NWSA) 3 Medium Narrow 18.55 0.93 3 Diageo (DEO) 3 Medium Wide 93.40 1.03 3 Nike (NKE) 3 Medium Wide 104.60 1.05 2 Google (GOOG) 4 High Wide 570.98 0.73 4 Mattel (MAT) 4 High Narrow 30.56 0.80 3 Data as of 06/01/12. Fund ownership data as of funds' most recent filings.
Owing to the selling activity that was initiated by Alleghany (starting in the fourth quarter of last year) to help fund its purchase of Transatlantic Holdings, both ExxonMobil and Devon Energy (DVN) made our list of top 10 sales this quarter. That's not to say that Alleghany was alone in selling, as Hartford Capital Appreciation completely eliminated its stake in ExxonMobil during the quarter, while Diamond Hill Large Cap made a significant reduction in its stake in Devon Energy, it's just that its sales had a far more profound impact on the rankings. Looking more closely at ExxonMobil, the stock accounted for more than 40% of Alleghany's stock holdings at the end of the third quarter of 2011, more than 30% of its equity portfolio at the end of the fourth quarter of last year, and less than 1% at the end of the first quarter of 2012. Having originally viewed the holding--which Alleghany built up after Burlington Northern (which also accounted for as much as 40% of the insurer's stock portfolio) was sold to Berkshire Hathaway--as a better-yielding cash instrument for the manager, we were not surprised to see Alleghany using it as a source of cash for its acquisition of Transatlantic Holdings.
Wells Fargo (WFC), which continues to be a top 10 holding for our Ultimate Stock-Pickers, saw a fair amount of selling activity during the first quarter as well, with four out of 12 managers reducing their stakes, including a meaningful sale by Prem Watsa at Fairfax Financial Holdings, which reduced his stake in the bank by one third, and a complete elimination of the holding by Hartford Capital Appreciation in its stock portfolio. Berkshire Hathaway, meanwhile, was the recipient of a major sale by Fairholme (FAIRX), which sold both Class A and Class B shares in meaningful amounts during the most recent period. And Intuit (INTU) was completely blown out by RS Capital Appreciation, with the fund managers noting that the decision to sell the holding was based solely on valuation, as the company shares have advanced meaningfully in recent periods (with the stock essentially doubling in price during their holding period of just over two years).
Given the negative news flow that continues to surround News Corp (NWSA), we were not too surprised to see the name hit the list of top 10 sales, as Dodge & Cox Stock, Mutual Shares, and Yacktman all reported fairly meaningful reduction in their holdings. Of these sales, Yacktman was probably the most interesting, as the managers of the fund had been fairly aggressive about buying up shares through the end of the third quarter of last year, and even noted that the shares were still inexpensive in their first quarter commentary, but still sold 5.8 million shares (or 15% of its stake in the media conglomerate) during the most recent period. That said, News Corp continues to be a top five holding for Yacktman, much as it has been over the last three years.
Looking over the rest of the sales, Diageo (DEO) was sold by three of the six managers holding the stock at the beginning of the year, with both FMI Large Cap (FMIHX) and Tweedy Browne Value (TWEBX) making meaningful reductions to their stakes in the premium spirits firm. Nike (NKE), which was held by six of our managers coming into the first quarter, saw meaningful reductions by both Jensen Quality Growth (JENSX) and Aston/Montag & Caldwell Growth, with Ronald Canarkis (manager of the latter fund) noting that he reduced his stake in Nike after the stock "had performed well on a relative basis and traded near all-time highs." As we noted in our last article, Canarkis was one of several managers that were making a meaningful number of new-money purchases, funded by the trimming of existing holdings, like Nike, as well as outright sales--like Halliburton (HAL), Emerson Electric (EMR), and Fluor Corporation (FLR)--during the most recent period.
As for the final two names, Google still made our list of top 10 holdings despite being sold by four of our top managers, with more meaningful reductions by Hartford Capital Appreciation and Aston/Montag & Caldwell Growth standing out. That said, Google did see a meaningful new-money purchase from FPA Crescent and a meaningful addition from RS Capital Appreciation during the first quarter. And finally, Mattel (MAT), which was held by five managers coming into the year, was completely eliminated from the portfolio at Diamond Hill Large Cap, with fairly sizable reductions taking place at Mutual Shares and Vanguard PRIMECAP as well.
If you're interested in receiving e-mail alerts about upcoming articles from The Ultimate Stock-Pickers Team, please sign up here.
Disclosure: Greggory Warren owns shares in the following securities mentioned above: Amana Trust Growth. It should also be noted that Morningstar's Institutional Equity Research Service offers research and analyst access to institutional asset managers. Through this service, Morningstar may have a business relationship with fund companies discussed in this report. Our business relationships in no way influence the funds or stocks discussed here.
The Morningstar Ultimate Stock-Pickers Team does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.