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Rekenthaler Report

The Strange and Happy Tale of Voya Corporate Leaders Trust

A fund that shouldn’t succeed, but does.

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Depression Baby
This story is neither new nor untold. There is more to be said about the subject, though.

Voya Corporate Leaders Trust (LEXCX), nee Lexington Corporate Leaders Trust, is the industry's oddest duck. Founded in 1935, the fund was the industry's first passively managed offering, beating Vanguard 500 Index (VFINX) to the starting line by a cool four decades.

The fund has a very different heritage from today's indexers. It wasn't launched to refute the claims of active management, based on academic research that suggested that strong performances usually regress to the mean. Rather, its strategy reflected its structure. Created before the Investment Company Act of 1940 was passed, the fund was established as a unit investment trust, and was therefore banned by regulations from actively managing its investments. 

So Lexington Corporate Leaders Trust bought 30 of the Great Depression's major companies--that number, one suspects, being strongly influenced by the Dow Jones Industrial Index--and waited. And waited. Its first five holdings, listed alphabetically, convey its original flavor: 1) Allied Chemical & Dye, 2) American Can Company; 3) American Radiator & Standard Sanitary; 4) American Telephone & Telegraph (T), and 5) Columbia Gas & Electric.

Not quite buggy whips and iceboxes, but unattractive businesses to modern eyes. To be sure, AT&T looks promising, being in the communications industry, and DuPont (DD), General Electric (GE), and Procter & Gamble (PG) also appear. But the fund owned few future consumer brands (no autos, no Coca-Cola (KO), no Gillette), no banks, and no insurers. It also overlooked IBM (IBM), which had posted a $7 million profit in the difficult year of 1934 and was growing rapidly.

Still Kicking
One would think that this collection of yesterday's businesses would have rattled along for a few years, perhaps even a few decades, and then expired. Quite the opposite. The fund not only continues to exist, but is faring quite well. In recent years, it has outgained the index more often than not. As I write this, the fund's 15-year returns are an annualized 137 basis points above the index's.

One reason for the fund's success is that it has, indeed, changed. It is not allowed to trade its positions, but the fund's companies certainly may take corporate actions. Which they have. Over the years, most of its initial holdings have been sold to other companies. If those deals were made through a stock swap, then the fund gained a new position. Investment management by accident!

(The most curious transaction came in 2010, when Berkshire Hathaway (BRK.B) bought the railway Burlington Northern Santa Fe. Breaking from his normal policy of buying businesses only with cash, or another company's stock, Berkshire chairman Warren Buffett agreed to finance part of the transaction with Berkshire equity. Voila! the fund became a Berkshire Hathaway shareholder, and the firm is now its second-largest holding.)

This process has gradually modernized the portfolio. Its school remains old, as industrials, energy, and basic materials account for 70% of its assets, but the names are familiar: Union Pacific (UNP), Exxon Mobil (XOM), Honeywell (HON). Aside from its top holding of Union Pacific, which takes up a whopping one third of the portfolio, the fund is fairly well-diversified, as 21 firms fill out the remaining two thirds.

Buying and Holding
The natural reaction when examining the fund's 1935 portfolio is to assume that the companies that no longer exist--at least under those names--were total failures. That is not necessarily so. Even if those firms eventually went bust, they could have distributed enough cash along the way to have been at least somewhat useful investments. And most did not go to zero. They retained enough value to become reincarnated, as business units of their acquisitors.

Also, the flip side of holding positions that gradually decline, without attempting to cut one's losses along the way--a tactic that typically is regarded as unsound, but that is baked into the fund's formula--is that the fund never sells its winners too early. Procter & Gamble's stock price alone, not including dividends, has gained an annualized 10% over the past 50 years. That makes for a 120-fold increase. It's just as well the fund didn't rebalance.

The fund has also benefited by being relatively cheap. Modern UITs typically carry up-front sales charges and have relatively short life spans. After a few years, they officially expire; investors who wish to stay the course must "roll over" their assets into a new UIT, thereby generating an additional sales charge. But this fund has no sales charge--and a termination date of 2100. At 0.59%, its ongoing expense ratio is high by UIT standards but low relative to equity mutual funds.  

Breaking the Usual Rules
Voya Corporate Leaders Trust shows that poor futurists can nonetheless achieve strong investment results, because companies that operate in slow-growth industries can generate high levels of cash for many years to come and can extend their lives through stock sales or by evolving their businesses. (Original holding F.W. Woolworth remains in the portfolio, except that company is now named Foot Locker (FL).) The fund also calls into question the standard investment practices of conducting due diligence and of rebalancing portfolio holdings.

The fund is therefore an instructive example. That said, it must also be granted that some of its success owes simply to luck. That the fund's initial investment decisions and unusual structure have not harmed it is remarkable enough. It would be more remarkable yet, but not credible, to claim that those aspects have helped it. They have not: Roughly speaking, the fund is positioned to match the overall stock market's long-term returns. That it is currently slightly better owes to chance.

In 2008, Voya Financial (VOYA) (then ING) launched an updated version of Corporate Leaders, called Voya Corporate Leaders 100 (VYCCX). This would be a proper passive fund, emulating the equal-weighted S&P 100 Index, with proper exposure to the 21st century's behemoths. It would hold pharmaceuticals, multinational banks, technologists, ... today's cutting-edge firms. A new fund for the new generation.

Voya Corporate Leaders 100 has trailed its elder sibling since inception. Go figure.

John Rekenthaler has been researching the fund industry since 1988. He is now a columnist for Morningstar.com and a member of Morningstar's investment research department. John is quick to point out that while Morningstar typically agrees with the views of the Rekenthaler Report, his views are his own.

John Rekenthaler has a position in the following securities mentioned above: BRK.B. Find out about Morningstar’s editorial policies.