Few places to hide

April 09, 2009

Diversified stock portfolios didn’t help investors stay afloat last year, but some Gulf Coast managers outperformed their peers over longer periods and bond investors shined.

In theory, owning a diversified portfolio of small stocks, large stocks and international stocks should help investors when one category is out of favor.

But that didn’t work for stock investors in 2008.

“All types of equity strategies were highly correlated last year,” says Gary Queen, investment consultant with Tampa-based CapTrust.

As every investor knows, they all correlated down. For example, the Standard and Poor’s 500-stock index fell 38% for the year ending Dec. 31.

CapTrust helps wealthy individuals and institutions select money managers and the firm compiled performance data for the Review’s annual ranking of Gulf Coast money managers. Using data from Zephyr StyleAdvisor, the Review ranked money managers based on their performance relative to peers who use the same investing style. For example, a manager who invests in large-company growth stocks was ranked according to how well his fund performed relative to peers who invest in the same kinds of stocks.

Money managers with a value investment strategy were hit particularly hard because many owned financial stocks, one of the worst industry sectors last year. Value-oriented managers generally select companies whose stocks are selling at low prices with the expectation that other investors will eventually recognize their greater worth and drive these stock prices higher. In 2008, that strategy backfired as frightened investors sold these kinds of stocks that appeared to be undervalued.

Private Capital Management of Naples, the Gulf Coast’s most high-profile money management firm, saw its flagship account fall nearly 49% last year compared with a decline of 36% for its benchmark, the Russell 3000-stock index. It was a major shareholder in Bear Stearns, among other financial stocks.

That one-year decline dragged down what had once been the firm’s stellar long-term record, according to data firm Zephyr StyleAdvisor. Its annualized five-year performance ending Dec. 31 dropped 6.97%, putting it at the bottom of its investment-style peer group.

The firm’s manager, Bruce Sherman, retired this year and longtime business partner Gregg Powers now runs the firm, which is now owned by Baltimore-based Legg Mason.

Assets managed by the firm fell to $2.4 billion at the end of 2008 from nearly $30 billion a few years ago, according to filings with the Securities and Exchange Commission. It’s not clear how much the asset decline was due to declining values or customer withdrawals. Private Capital Management officials couldn’t be reached.

By contrast, other Gulf Coast money managers with a lot less money under management performed significantly better than their peers. Firms such as Frantzen Capital Management and Strategic Investment Partners (SIPCO) have good long-term track records despite a tough year last year.

“I wouldn’t make much of the one-year numbers,” says CapTrust’s Queen. A five-year track record reveals a manager’s skill over good and bad years, when different investing styles move in and out of favor.

Meanwhile, bond investors were among the few winners last year. Still, with U.S. Treasuries yielding so little and corporate bonds facing greater prospects of default, it was a treacherous year for bond managers too. Fortunately, Gulf Coast fixed-income managers at Wasmer, Schroeder in Naples and Eagle Asset Management in St. Petersburg navigated those dangerous waters well relative to their peers, Zephyr StyleAdvisor data shows.

Small firms do large caps
Two small money management firms in Tampa — Frantzen Capital Management and SIPCO — have accounts that invest in large-company stocks and scored among the top 20% of their peers over the five years ending Dec. 31, 2008.

Frantzen Capital’s Large Cap Growth had a poor year relative to its peers in 2008 but its five-year track record still stands out because of bets in 2007 on materials and consumer-discretionary stocks that outperformed the market that year.

“We gravitated a little more to health care in 2008,” says Michael Via, Frantzen’s chief investment officer. “That group ranked right up there with financials being very, very weak.”

For 2009, Via says cyclical stocks such as technology, consumer discretionary, energy and materials may lead the market higher as the economy recovers. Via likes phosphate miner Mosaic Co. (symbol, MOS; recent stock price, $46) because a global recovery means more food production in emerging markets. Technology is also a good bet in a recovery, with stocks such as Apple (AAPL; $116), Oracle (ORCL; $19) and Symantec (SYMC; $16). Frantzen Capital manages about $33 million.

Apple and Oracle also are on SIPCO’s list. The Tampa firm that manages about $25 million looks for companies that will survive the downturn, says Timothy McIntosh, the firm’s founder, chief investment officer and portfolio manager. The firm seeks stocks of large companies with low prices relative to companies’ earnings, sales, cash flow and book value.

McIntosh says he’s even looking at financial service companies with good balance sheets and managements such as Goldman Sachs (GS; $119), Bank of New York Mellon (BK; $29) and PNC Financial (PNC; $36). “They’re names we like,” he says. “They’re survivors.”

Besides technology and financials, SIPCO also focuses on health care and energy. In health care, biotech is a favorite sector with companies such as Gilead Sciences (GILD; $47). In energy, oil drillers such as Transocean (RIG; $66) and Schlumberger (SLB; $45) are promising picks, McIntosh says.

Small stocks with bigger returns
If the economy recovers as most believe it eventually will, small stocks are likely to be among the first to benefit. “We’re seeing signs the economy is bottoming,” says Eric Mintz, assistant portfolio manager for Eagle Asset Management’s
Small Cap Growth portfolio. Recently, signs included better-than-expected reports about manufacturing and orders for new goods.

Mintz, who looks for stocks of small, fast-growing companies with reasonable share prices, says technology is an area that will benefit from a rebound in the economic cycle. Netflix (NFLX; $43), the movie-rental-by-mail company, is one of the fund’s biggest holdings, for example.

Being early can pay off. “One of our biggest mistakes was not buying Best Buy when Circuit City was liquidating,” Mintz says. At the time, the electronics retailer’s stock (BBY) was trading at $18 and it’s now around $40.

At Frantzen, Via says he’s seeking energy and infrastructure companies for the small-stock growth account. Two promising companies that will benefit from federal stimulus spending in those areas include MasTec (MTZ; $14), which installs telecommunication and energy transmission lines, and ITC Holdings (ITC; $43), which builds, operates and maintains electric transmission lines.

David Adams and John “Jack” McPherson, co-managers of Eagle Asset’s Small Cap Core, look for companies that aren’t widely followed or they’re misunderstood and even disliked. This value-oriented approach helps the team find companies whose stocks have limited downside but also have potential for great returns over two to five years.

For example, Adams and McPherson have invested over time in a company called Amerigroup (AGP; $28), a Medicaid managed-care provider that should benefit from government seeking to lower health-care costs. Medicaid is the insurance program for low-income people that is funded by state and federal governments. They sell some of their holdings when the stock rises, as it did about a year ago, and buy when it falls below their parameters. “We will definitely trade around the edges,” Adams says.

Adams and McPherson are currently looking for opportunities in natural gas because they believe values may fall below the threshold for demand in that sector.

“Is right now the bottom? Probably not, but we’re looking pretty hard in the energy area,” McPherson says. One stock the firm has been buying is Foundation Coal (FCL; $16), which provides coal for electricity generation. “Even with a slower economy, electricity generation won’t drop by 50%,” McPherson reasons. When the economy does recover, Foundation Coal will benefit. “We don’t mind being patient,” McPherson says.

Bonds shine in down markets
Bond managers who performed well in 2008 were the ones who avoided the big mistakes. Two of the more nimble managers were James Camp at Eagle Asset Management in St. Petersburg and Michael Schroeder at Wasmer, Schroeder in Naples.

Some managers were lulled into a false sense of confidence because some lower-quality bonds had insurance that made them look better to investors. As it turns out, bond insurance didn’t turn out to be the great protection it was billed as insurers themselves faced challenges.

“It’s put refocused effort on credit research and due diligence at the issuer level,” says Schroeder, president and chief investment officer at Wasmer, Schroeder. In the five years leading up to 2008, 40% to 60% of municipal bonds came with insurance from private insurers such as AMBAC and MBIA. In 2008 that fell to 18% Schroeder says.

At Eagle Asset Management, research helped the firm avoid bonds of companies such as Lehman Bros. and Wachovia. “We were out in front of the rating agencies and out in front of trouble,” says Camp. “It was primarily dodging bullets.”

This year, Camp expects federally insured mortgages to outperform the market and he’s also considering bonds of corporations that are backed by the Federal Deposit Insurance Corp. “It’s an intriguing new avenue for us,” Camp says.

For tax-free investing, Schroeder says municipal bonds will continue to be appealing.

“Taxes are going to rise,” Schroeder says. Much of the federal stimulus will be headed to municipal coffers and that will provide a floor for the municipal bond market. The relative safety of munis also is appealing.

“The stock market has been so volatile and returns have been so shaky that people who would ordinarily look at the stock market are investing with us,” Schroeder says.