Bottom-up investors say they ignore macroeconomic trends and focus solely on the quality of a particular business. Of what consequence are unpredictable outside forces, the thinking goes, if you know a company inside and out?
For years, Chuck Akre, manager of the $280 million Akre Focus fund, was in that camp too. Running the FBR Focus fund through much of the tremendous bull market of the 1990s, it served him well. Periodic dips were simply opportunities to buy more of what he liked.
But the 2008-09 market crash made him realize that macroeconomic forces have a greater effect on investor sentiment than he cared to believe. Although FBR Focus sank 33.8% compared with the S&P 500's 37% drop and the mid-cap growth category's 43.7% plunge, Akre was left thinking he could do better.
"What became very clear to me was that few people were connecting all the dots at the time," he says. To be sure, few investors predicted the degree to which several asset classes would collapse at once. Yet Akre wants to understand all the inherent risks in his investments.
"I'm trying to make sure we're constantly integrating our worldview with our portfolio," he says. It's a good thing, too, because the economic picture Akre sees on the horizon is grim: little to no U.S. growth, high unemployment, constrained consumers and rising inflation.
The picks in his fund, Akre says, should not only be able to withstand a tough economic environment, but thrive in one. Recently, he's set his site on consumer discretionary names that appeal to the budget conscious. The result is a portfolio of equities that have average growth rates but valuations slimmer than the market.
Although his current offering is only two years old, Akre is off to an impressive start. For the 12 months ended Oct. 13, the fund is up 4%, placing it in the top 7% of mid-cap growth funds, according to Morningstar.
FORGING AN INDEPENDENT PATH
Akre formed his investment advisory firm, Akre Capital Management, in 1993. Based in Middleburg, Va., the company acted as the sub-advisor to the FBR Focus fund until he parted ways over a dispute regarding his management fee in mid-2009. About a month later, he launched his current offering. Building on the enviable 12-year record he amassed there, Akre manages the fund the same way.
For an investor with a value tilt, 2009 was not an ideal time to be on the hunt for bargains. As stocks rebounded, Akre found the market too frothy, and he was slow to part with his cash, a move that drew the ire of some investors because the fund failed to keep pace with the major averages. "The market was on a tear and we didn't want to participate in that," he says. "I think we did the right thing."
Perhaps. But 2010 put Akre in unpleasant terrain - near the bottom of his category. As the typical fund in the mid-cap growth category posted a 24.6% gain, Akre Focus advanced 19.5%, largely because of the cash drag. That landed the fund in the bottom 18% of the group.
Akre Focus now has 11% cash; the manager says some liquidity is essential to meet unexpected redemptions and take advantage of buying opportunities quickly. This year, the fund is up 3.5% through Oct. 10, better than 98% of similar offerings.
To find stocks for the fund, Akre and his analysts come to their picks independently and only later share them with the larger group. After 40 years in the business, Akre knows what he likes - his picks are the result of his research and conversations with business leaders.
The companies that are added to the portfolio share some similar traits. Akre looks for high returns on equity. He's also looking for a sustainable competitive advantage and the ability to produce large amounts of free cash flow. Cash is important, he says, but only if management has good plans for it. Executives who act in the best interest of shareholders is something else Akre wants to see.
Amid the sluggish economic environment, Akre has gravitated toward discount retailers, such as Dollar Tree, Ross Stores and TJX Companies (parent of T.J.Maxx and Marshalls). "These are businesses that help the consumer stretch the dollar," Akre says. The companies also have enviable balance sheets, with greater amounts of free cash flow than debt, which should give them flexibility should business financing become constrained again.
Valuation-wise, the stocks are also well priced: Dollar Tree recently traded at 17.5 times next year's earnings, Ross at 13.9 and TJX at 13. The stocks have proven resilient: Dollar Tree was up 54% over the last three years annualized, Ross gained 45% and TJX added 32.4%.
CarMax is another pick. The seller and financier of used cars can take advantage of buyers' reluctance to spend on new cars. The majority of used car sales are still done at a dealer ship and CarMax has only a 3% market share. Akre believes the company can continue to grow by snagging customers from dealers. Akre likes CarMax's business model, which allows it to take advantage of its national platform of 100 stores to move cars to where they are most in demand.
"They invented a whole new way of selling used cars and they've continued to take market share in virtually every market they're in," Akre says. Over the last 12 months, CarMax is down 9.4%.
BANKING ON CREDIT CARDS
When MasterCard and Visa began to sink earlier this year due to impending debit card fee caps, Akre grew interested. But before he would invest, he needed to understand what exactly the new law would mean to the stocks.
The regulations require banks to cap their fees for debit card transactions. By talking with former regulators, lawyers and business consultants, Akre concluded MasterCard had very little exposure to debit cards, the cards whose fees the law capped at 24 cents per swipe, down from the previous 44 cents. Akre found that credit cards, not debit cards, are MasterCard's bread and butter.
"On the surface, MasterCard's business model is quite simple and straightforward," Akre says. "Beneath the surface, however, it's quite complicated because they touch each of the issuing banks in myriad ways, each of which has a cost associated with it."
With just 22 positions, Akre takes his time before issuing a buy order - he researched MasterCard for months before moving forward. MasterCard is up 46.6% over the last 12 months and has a P/E of 15.7 future earnings.
No matter how badly the economy performs, some trends are so ingrained that they defy a low-growth environment. One example is telecom. But rather than casting his sights on the latest smartphone or app, Akre has chosen a less glamorous route: cell- phone towers.
American Tower Corp. builds towers and leases them to cellphone carriers. "The tower business is vertical real estate," he explains. "They charge rent per tenant that is located on their tower." Once a carrier signs up with American Tower, tenants tend to stay for the long haul. American Tower's contracts include annual rent increases, which means revenue will likely stay ahead of inflation.
American Tower doesn't come cheap. With a forward P/E of 41, it's the highest valued stock in Akre's portfolio. "That's pretty expensive for us," he says. The stock has a return on equity of 10.9% and is up 11% over the last 12 months. Akre believes the price is worth it for the predictability of the business model. "That's what you're paying for," he says.
Ilana Polyak, a New York writer, has contributed to The New York Times, Money and Kiplinger's. She writes regularly for Financial Planning.
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