Air date: October 22, 2004
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Successful small funds
KAREN GIBBS: Investors have about $7.5 trillion stashed away in mutual funds, the vast majority invested with the biggest, most well known fund families. So that raises an interesting question: are you better off going with the lumbering giants, or seeking out smaller funds flying below the radar? Here's a fact that might help. Of all the equity funds managed by industry titan Fidelity, 66 percent of them are underperforming the competition so far this year.
Our friends at FORTUNE have scanned the market landscape and come up with what we consider the seven best boutique funds. We have three of those fund managers in our studio. John C. Thompson's Thompson Plumb Growth Fund has returned an average of 11 percent annually for the past five years. Bernard Horn's Polaris Global Fund has an average annualized return of 11.5 percent. And Ron Muhlenkamp's Muhlenkamp Fund has posted an average of 13.6 percent annually over the past 5 years.
So, Ron, what type of advantages does a small firm have over a large one?
RON MUHLENKAMP: Well, you have several advantages. The large firms tend to be somewhat sales oriented. That is they sell people what people think they want to own, and the difficulty is is what most people think they want to own is usually passé. We have one fund.
A man called one day, he says you've only got one fund, I can't switch. I said if you know when to switch, you don't need us. So we serve that function, and we are independent. We're very independent. And we simply look for the best investments we can find, which usually means they're unpopular at the present time. And in fact we tell our clients we're paid a fee to disagree with them, and if they can wrap their mind around that, they become very good clients. If they don't wrap their mind around that, they tend to go to the big firms.
GIBBS: Bernie, why a boutique and not a behemoth?
BERNARD HORN: Well, there are a lot of really good reasons for why maybe smaller investment managers tend to outperform the larger competitors. The first is really that we can pretty much go anywhere. We're not beholden to a certain index. We don't have to buy only the largest companies. We can buy small companies if they're the best place to put your money, or we can buy the largest companies if that's the case. But the other reason is that we don't really have any committees. We don't have to write long memos just to buy companies that might be in or out of our index. So those are the two most important.
GIBBS: How about you, John? What's the attraction?
JOHN C. THOMPSON: At smaller firms we can make decisions that we think are best for shareholders in the long run, and if it happens to be unpopular at the time, we can choose to deal with that and it works out well.
GIBBS: Bernie, when you look at investors that want to put you in a box, a style box or so, and you say you're a go-anywhere fund, so you're not really easy to pigeonhole?
HORN: Well, we're not really easy to pigeonhole, and for many advisors sometimes that's difficult. But we really have a discipline that we want to stick to, and sometimes that means that if the world is going one way and we really believe that the best values are in another direction, we're going to stick to that. And it's something that we learned a lot of different times, but probably the most valuable time that we learned that lesson is in the dotcom bubble when many people were just chasing companies that had very little value and no long-term sustainable business plan. In the end, these business plans never really had any sustainable value, and consequently the reason that we're making great returns right now is simply because at that time we were buying things that were out of favor, great value, and thus far have proved their worth.
GIBBS: Any particular example, Ron, that you can give us of swimming upstream, going against the grain?
MUHLENKAMP: Well, '99 was a great year. We looked pretty dumb in '99 when the technology stuff was running. You may recall that in '99 there were more stocks down than up on the New York Stock Exchange, that a lot of stocks, which frankly is normal when the Fed's raising interest rates. In 2000 I'm told there was a bear market, but we were up 25 percent. In 2001, we were up 9 percent. People like to ask me which way the market's going. Well, we've had a split market for at least six years now. I mean the Dow does one thing, the S&P does something else, the Nasdaq does something else, because they're tracking different things. And you can get lost or confused in those things.
What you need is a manager. You need a set of criteria. We tell people they need a rock to stand on, something they trust more than they trust public opinion. The ticker tape will tell you what public opinion is, but unless you've got a rock to stand on in terms of the criteria that you're looking for, you're going to be floating with that stuff, and you need that.
And then, frankly, the head part of our job is easier than the stomach. When the head tells you one thing and the public opinion is something else, you double check the numbers. But if the numbers hold up, I write memos to myself, and I write down, okay, it's stomach time. It's time to be sure that I believe enough in what I believe to go against the crowd, and we've just come through a six-year period where that was in spades and the way you ended up with decent returns. And of course we lost clients in '99. I suspect these guys did, too. Clients who had been clients for 20 years said, "Ron, we like what you do, but we think you're just out of touch with what's going on here." Well, I concluded there was a fad going on. I learned in high school that I'm not very good at fads, and we simply chose not to play.
GIBBS: Well, you're right about these markets. They have been mixed. In fact, it was another mixed week for the market with the Dow suffering triple-digit losses, but the Nasdaq up almost 30 points, while the S&P 500 lost about 7 1/2 points on the week. So, Ron, is the economic glass half empty or half full?
MUHLENKAMP: We think the economy's in good shape. We think inflation's on the order of 1.5 to 2 percent, long bonds should be at 4.5 to 5, by that I mean the 30-year bond, it's there. Frankly we think we're back to normal, but it's a normal we haven't seen since 1965.
GIBBS: 1965 being normal?
MUHLENKAMP: Well, 1965 was the last time we had inflation at 1.5 percent. I can show you reports from the late '60s even the early '70s that proved that 4.5 is a normal interest rate on a bond. My father thought a 4.5 percent mortgage was normal. And those same studies prove that a 17 is a normal P/E on stocks. I believe value line says the median P/E today is about 17.5 to 18. So, yeah, we think we're back to normal. If I'm right, us old guys with the gray hair have an advantage because we've been there before.
GIBBS: Bernie, what's your outlook on the U.S. markets?
HORN: Well, we think that the economy in the U.S. is one of the most resilient, competitive economies in the world. As far as the valuation of stocks are concerned, when we look around the world, we see the U.S. market as being one of the more richly valued markets. The reason for that is because we had this tremendous bull market right throughout the 1990s, and although we've had a correction from 2000 to date, it really hasn't corrected the difference between the valuations in the U.S. and the valuations outside the U.S. It just means that there are really good values and sometimes, and in many cases much better values outside the U.S. right now.
GIBBS: John, you have a different take on the U.S. economy and the stock market.
THOMPSON: Yeah, first of all we think inflation is running a lot higher than what the statistics are showing.
GIBBS: Why do you say that?
THOMPSON: If you look at oil prices, housing prices, medical costs, basic materials, copper -- there's a whole slew of products that I think the average person would agree we're all paying more for goods now than we have in past years.
The second thing is that we look at the balance sheets of both companies and individuals. Companies' balance sheets have gotten a lot better in the last couple of years as they've cut costs and paid off a lot of debt. However, consumers have actually done the opposite and have been levering up and have continued to lever up by taking equity out of their homes. And in fact consumers today are spending more than they earn and they're making up the difference by borrowing it off their home mortgages, and this is an aggregate, and we think that's unsustainable. And so we're thinking that the consumer is going to get weak, and we haven't had a consumer recession in 15 years approximately, and we think it's a distinct possibility.
GIBBS: Ron, let's get back to that, because we had a Fed governor this week come out and say that higher oil prices are here to stay and the consumers are certainly feeling that. It's acting as a tax on them, as well as (ensuring that) interest rates are going to continue to rise. Doesn't that outlook kind of temper your enthusiasm?
MUHLENKAMP: The public every now and then shifts their focus a little bit, and when they do they tend to do it across a recession. What we found interesting about this recession is, Harley-Davidson didn't notice, Winnebago barely noticed.
Winnebago saw some of their competitors cutting prices, and they said if people are buying class A motor homes, which are $100,000 to $200,000, and a third of them pay cash, maybe they're more interested in fit and finish and 24-7 roadside service than they are in a price cut. So they put a little more money into that, and they barely noticed the recession, which I find astounding. I mean nobody needs a Harley-Davidson or a Winnebago.
GIBBS: Okay, John, where are you putting your money?
THOMPSON: Consumer staples.
GIBBS: Such as?
THOMPSON: Coca-Cola, General Mills, Colgate, things like that where you have to buy it no matter how much your income has gone down because the price of oil's gone up.
We also like some financials, Fannie Mae.
GIBBS: Fannie Mae, considering its accounting problems?
THOMPSON: Yes. It's a controversial name, but it's trading at 8 times earnings, which is actually -- if you look at its history, it's traded anywhere from about 7 times at the lowest point it's ever traded at in the last 20 years to approximately 25 times earnings at the highest that it traded at. So its valuation is very close to the bottom. It's been a tremendous growth company over many years. They supply mortgages to the average and lower income Americans.
GIBBS: But if the economy slows, then those lower income Americans aren't going to be able to continue to sustain that type of buying pattern.
THOMPSON: Well, what they can do, though, it's a $7 trillion mortgage market. They control -- Fannie Mae has about $1 trillion, so they could just go into the open market and buy mortgages. They don't need houses to be built or people to buy and sell houses or people to refinance.
GIBBS: But isn't that one of the problems with Fannie Mae, that people are saying they're getting away from their business and they're out in the market buying and selling securities?
THOMPSON: Well, they were founded in 1938 by FDR to provide a secondary market for mortgages, so buying and selling mortgages in the open market is providing a secondary market.
GIBBS: I saw you nodding your head just a little bit, Bernie.
HORN: Fannie Mae is coming up on our screens as well, and it is without a doubt a cheap stock, and it's the kind of company that we tend to be attracted to because if it is a little bit controversial, sometimes it makes them look like good value, and Fannie Mae certainly is. I think the only concern we still have on Fannie is that we've been talking to a lot of New York bankers, and they were complaining somewhat bitterly that they were in the commercial multifamily housing market, and it was their complaint that Fannie decided that they were going to broaden their reach and go from helping people buy houses and affordable houses to now competing against the larger banks in the multifamily housing market. And I think that's really what's got the attention of the regulators.
And ultimately this is a company that is definitely going to be around. It's going to survive, it's going to be a good value, and people are going to make money on the stock. But I think that the regulators are at this point trying to rein them in a bit, and we'll see how long that takes, but eventually it will come out of it.
MUHLENKAMP: Here's where you need the rock to stand on. Fannie Mae is a very good company. The only way you can buy a good company at a cheap price is if somebody don't like it. And so you've got to conclude whether these, the current problems, change the nature of the company or whether there's something that's a problem but will pass and the company goes on with it. But the only way you can buy a good company at a cheap price -- we tell our clients that we're trying to buy Buicks at Chevy prices. We'd like to buy Cadillacs, but they don't go on sale very often. Fannie Mae is a Cadillac. Right now it's on sale. What you have to decide is whether it -- it certainly has been a Cadillac, now there is some debate as to whether it will be next year or not, but that's the dialogue that's going on.
The last great time you had a chance to buy drug stocks was when we worried about Hillarycare. All of a sudden, things like Merck we're starting to take a look at. You know, is the problem permanent, or is it overdone? Well, here's where you need the rock to stand on in order to give you a perspective with the current opinion.
GIBBS: Ron Muhlenkamp, Bernie Horn, John Thompson, thanks so much for joining us.
(Click here to read more about their funds, as well as four others named by FORTUNE as the best of the boutique funds)
Vanity investing
GEOFF COLVIN: What's it worth to you to look younger? How about if you're a man, in an increasingly competitive workplace where older workers are seen as less productive, less creative -- less hirable and desirable? Add the aging of the baby boomers, and you've got the makings of a trend, a big one -- more men having plastic surgery, cosmetic dentistry, and other procedures to look younger. In a recent poll, 50 percent of men said "a youthful appearance is an important factor in professional success" -- so it's no surprise that the number of men receiving Botox injections is up 152 percent. Where's this trend headed, who's profiting from it, and how can you invest in it?
Elizabeth Fenner is an editor at FORTUNE magazine.
Beth, five years ago, the phrase "lipo my flanks" is not one that most men would have known the meaning of, but today an awful lot of them do. What has happened?
BETH FENNER: What has happened is it's a combination of TV shows like Nip and Tuck -- where people are understanding what all these procedures are, and it's not just women, but men that watch these shows -- and there's also a fear, I think, of aging and age discrimination in the workplace. We see that complaints to the EEOC for age discrimination are way up. And so people, they want an edge, as you said, anyway they can get one, and if looking younger is part of it, they'll grab it.
COLVIN: And they really believe that is part of it.
FENNER: Yeah.
COLVIN: What is it about a show like this that so captivates the attention of the country?
FENNER: It's sort of like a car wreck. You almost can't look away. You can't believe that someone is allowing this to be filmed. It's so intrusive and so intimate a procedure, but then it starts to seem normal. And then you think, well, if they can do it, maybe I can do it.
COLVIN: I think that part of what's making this acceptable, or so it seems to be, is a number of high-profile men have had some work done and have gone public about it.
FENNER: Only a few, though. A lot of them won't talk about it.
COLVIN: A lot of them won't admit it, that's for sure. But if you have (looked) -- I mean, House Majority Leader Tom DeLay a couple of months ago had some work done around his eyes, and you can see the difference there in the before and after photos. Media mogul and Italian Premier Silvio Berlusconi looks noticeably tightened up right there. He had work done last December, and the nation of Italy was transfixed by it at the time. Even the most difficult cases can be helped.
We asked Dr. Garth Fisher of Beverly Hills to see what he could do for this poor guy, so on his computer Dr. Fisher performed a brow lift, lower eyelid lift, face lift, subtle rhinoplasty, collagen injections, and a whole lot of hair transplantation. And this is what you get.
FENNER: It's really something.
COLVIN: Let me just say, I'm not ready and not only will you never see that picture again, you're not going to see the effects either, at least no time soon. Is part of the trend here that the procedures are just better, the surgeons are better, it's easier, it's faster, it's cheaper?
FENNER: Well, clearly the procedures are better for things like liposuction. They've done really great advances there, and so it's getting better all the time. And so you can really go for an eye lift apparently, say that you're going on a cruise and come back two weeks later and nobody's the wiser.
COLVIN: It is pretty amazing. It's also, I gather, a big profit center for surgeons, right?
FENNER: Absolutely, and a lot of these things aren't covered by insurance, so they get their money right up front. And you schedule them in advance and none of these nasty emergency things that happen, so it's great for them. They love it.
COLVIN: Wonderful. It's not just surgery, right? There's also dentistry. Cosmetic dentistry is a big thing. What's happening there?
FENNER: Well, the big thing there are porcelain veneers that you sort of put on each tooth and they're white and they cover all the cigar and red wine drinking you've been doing over the years. Several people have been rumored to have had these things affixed to their teeth. Donald Trump is one. Sumner Redstone from Viacom is another. Now, these are just rumors.
COLVIN: I understand.
FENNER: You know, again, you be the judge. Look at the before and after and see what you think.
COLVIN: Right, well, but it's another perfect example of what aging baby boomers are doing, because the teeth do get yellow, more stained and so forth, and white teeth are a real sign of youth.
FENNER: Absolutely.
COLVIN: So that's happening. How brutal is the situation in the workplace? Because I suspect that's a big factor.
FENNER: Well, a recent poll has shown that senior executives polled said that 94 percent of them feel that they have missed out on a job opportunity because of their age.
COLVIN: 94 percent?
FENNER: Which is huge.
COLVIN: That's everybody.
FENNER: Basically. I mean the fear, which shows you, whether or not that's true, they perceive it to be that way, and that's what's driving all this.
COLVIN: How much of it is men seeing women getting these procedures and thinking, "Gee, I'd better keep up?"
FENNER: That may be part of it. I mean you've certainly seen that vanity is an equal opportunity vice, if you will. I mean, men are going to the gym in greater numbers, they can't have the love handles. Wrinkles are the natural next frontier.
COLVIN: Well, in fact men now make up 18 percent of the patients having cosmetic surgery, certainly a minority, but a much larger minority than it used to be. The most popular procedures for men are apparently nose jobs, eyes -- like Tom DeLay and Mr. Berlusconi had -- and I always heard liposuction (saying the first syllable as "lype"), you say liposuction (saying the first syllable as "lip"), what's correct there?
FENNER: Actually I'm not sure. I think it's one of those tomayto-tomahto things, I hope.
(Online editor's note: Her hopes are well-founded. According to The American Heritage Dictionary of the English Language listing on dictionary.com, either pronunciation is acceptable)
COLVIN: Okay. Let's talk about all the businesses that could be capitalizing on this. Now there are some companies that we've found. One is Medicis Pharmaceuticals. They have a market niche in dermatology, especially wrinkle cream. And what's the name of that one?
FENNER: It's called Restylane, or Restylane, now I'm not sure. But it's one of these, it was just approved by the FDA in September, and it's a wrinkle filler. You inject it into the wrinkles and it makes them go away.
COLVIN: You inject it.
FENNER: You inject it, and so a doctor must perform this. And some analysts are saying this could be a $100 million business for them.
COLVIN: Huge.
FENNER: Huge.
COLVIN: Inamed, currently a major player in Botox and the implant business, also Sybron Dental Specialties and Patterson Companies. The trend there is orthodontists are gearing their practices towards adults with braces, not just kids with braces anymore. And sometimes dental work is cheaper than other cosmetic surgery, so that if you can't pony up for the whole face lift, at least you can go have a little work done on the teeth. Although I think those veneers you mentioned can be quite expensive.
FENNER: They're about $2,000 a tooth.
COLVIN: Per tooth.
FENNER: So if you just want one tooth, you better kind of get all the teeth done.
COLVIN: Yeah, you better get the whole set. What other companies have got products that are big in this area?
FENNER: Well, a lot of people don't want to do an invasive procedure, but they will want to smooth on a cream that will do something. And there are indeed ingredients that have been proven by the FDA to smooth out wrinkles. Renova, Retin-A type ingredients, Retinols they're called. And so a lot of companies that make face creams like Estée Lauder can benefit, and there are also companies like J&J...
COLVIN: Johnson & Johnson.
FENNER: Procter & Gamble, yes, but they have such big businesses that that might not affect them. In fact their bottom line's in a real tangible way that you can see.
COLVIN: Right. Do you have any sense of what's next as we go down this road? I mean if anyone had told you five years ago that people would have plastic surgery so they could be on television, as in these shows like The Swan and Extreme Makeover, you would have said no way, and yet it's happening. Where are we going?
FENNER: I wish I knew. I think it's frankly terrifying, and I wish it would stop pretty soon. I mean there's a level at which you don't want to go if you see some of these plastic surgery victims who are older who've had numerous surgeries. I mean, can't we see that that's not good?
COLVIN: The Joan Rivers syndrome.
FENNER: Well, I was going to mention her.
COLVIN: Yeah, well, why not? You mentioned earlier that vanity is an equal opportunity vice, but the truth is it's a sort of bizarre step forward in equality of the sexes. Women have been objectified forever, and we're really reaching a point now where men are being objectified also. You look at some magazine covers, and it's unbelievable.
FENNER: I have to say there are a number of women I know who are sort of yeah, it's their turn now, you know, they have to suffer for beauty just like we do. So there's a certain satisfaction in that.
COLVIN: Well, for some, for some. But the media have played a major role, arguably the major role in this, yes?
FENNER: Well, certain kinds of media have certainly. I mean there's the impossibly airbrushed creature on the cover of Vogue, and it's hard to live up to.
COLVIN: Have we reached the point where it's acceptable for a man who has obviously had some procedures done to walk into the boardroom and nothing is said?
FENNER: I think that that's not progress. The progress would be if the man, like Berlusconi, were to say, yes, I had it done and what's wrong with that? And maybe that is what we'll start seeing.
COLVIN: Well, we're just about there. Berlusconi denied it in the original instance and eventually the pressure was so enormous that he said, yeah, it's okay, and no one cared.
FENNER: Yeah.
COLVIN: Beth Fenner, thanks so much for your insights on this.
FENNER: It was fun.
Next week: See how the stock market is the single most accurate predictor of Presidential races
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