Quick Take: The Putnam Tax-Smart Equity Fund/A (PATSX) invests in undervalued large-cap stocks while monitoring and minimizing taxable distributions to shareholders.
For the three years ended January 31, the $293-million fund gained 5.1% annualized, versus a drop of 0.4% for the average large-cap growth fund. The portfolio outperformed over the five-year period as well, edging down 0.2%, while its peers fell 7.0%. For the one-year period ended in January, the fund gained 7.9%, versus a gain of 2.2% for the peer group.
Putnam Tax-Smart Equity fund is less volatile than its peers, and boasts a lower turnover rate. Expenses also run lower than the peer group average. Richard Cervone and James Yu joined the management team in March 2004. Jim Weiss is the fund's lead manager.
The Full Interview:
S&P: What are your buy criteria?
CERVONE: We use a strictly bottom-up process to construct a portfolio of large-cap securities we think are trading at prices below their intrinsic value. The most important determinant for 'value' is discounted free cash flow — we are also cognizant of parameters like capital allocation, dividend growth, share buybacks, etc.
We are not 'value' investors in the low price-earnings (P/E) or low price-book sense. We invest in stocks with relatively high P/E's, like eBay (EBAY) and Apple Computer (AAPL), because we believe these shares are under-priced relative to their future cash free flow.
As a secondary objective, we monitor the portfolio on an after-tax basis and consider the federal income tax consequences of buy and sell transactions.
S&P: What are your largest holdings?
CERVONE: As of Dec. 31, 2004, our top ten stocks comprised Microsoft Corp. (MSFT), Citigroup Inc. (C), Exxon Mobil Corp. (XOM), Johnson & Johnson (JNJ), Pfizer Inc. (PFE), Altria Group Inc. (MO), Cisco Systems (CSCO), Fannie Mae (FNM), American Intl. Group (AIG) and Commerce Bancorp Inc (CBH).
These holdings represented 32.8% of the fund's total assets. The fund had 112 stocks as of Dec. 31, 2004. We typically range between 80 and 100 holdings in the portfolio. Sometimes, we will take small positions in mid-cap stocks we find attractive.
S&P: What are your top sectors?
CERVONE: As of Dec. 31, 2004: Financials, 31.1%; Technology, 16.5%; Healthcare, 14.8%; Consumer Cyclicals, 14.6%; Consumer Staples, 8.1%; and Energy 7.1%.
S&P: Are your largest holdings necessarily your favorite picks?
CERVONE: Not necessarily. For example, Exxon-Mobil is a major component of the S&P 500 Index, but it's only a 1% overweight position in our fund. On the other hand, Commerce Bancorp Inc (CBH) is not even in the S&P 500 Index, but it's a significant position in our fund. As a result, a holding like CBH has a greater impact on our performance than Exxon would, though its absolute weighting is smaller.
S&P: Your largest sector is financials, which are quite vulnerable to rising interest rates.
CERVONE: We are overweight in financials relative to the S&P 500 Index, but that doesn't reflect any overall sector view. It's driven by the fact that we are finding many undervalued individual companies within that sector. We own stocks like Everest Reinsurance Group Ltd. (RE), a reinsurer; and General Growth Properties (GGP), a REIT that owns malls. Neither of these companies are in the S&P 500 Index, but they are great businesses whose shares, we think, are undervalued.
We tend to favor companies that dominate niche businesses, because they can usually create some kind of competitive advantage that will benefit shareholders over time.
