During the past several years while virtually all the net flows for mutual funds went to value funds, there was a small cadre of growth funds that performed very well relative to their growth peer group. Are they poised to continue or even improve that performance now that the pendulum seems to be swinging back toward growth? After all, if these growth funds performed so well during the value-favored years, does it make sense that they would do well when growth is in the driver's seat? With those questions in mind, we picked the brain of a growth fund manager who has consistently beaten his peers during the value years, Tony Y. Dong, director, mid-cap equity and senior portfolio manager at Munder Capital Management in Birmingham, Michigan.
Dong, lead manager of the $1.437 billion Munder Mid-Cap Core Growth/A, (MGOAX), says that one reason the fund has outperformed relative to its peers during the value years is because, "We're agnostic with regard to where we look for growth, and how we define value. For example, growth managers typically look to favorite industries or sectors such as technology, or consumer discretionary, or health care, for their growth ideas, but we'll look for growth wherever we can find it. For example, we had home builders for the last few years, and through 2003 and 2004 they were very good performers."
The fund's performance numbers support the wisdom of Dong's approach: For the five years ended February 28th, the fund earned an annualized average total return of 11.51%, versus 2.59% for its mid-cap growth peer group; and an annualized average of 27.10% versus 21.86% for the three-year period, according to Standard & Poor's, which gives this fund its highest ranking, five stars overall and in the three-and five-year categories.
How much money do you have under management? We have $2.5 billion in mid cap [in all of the classes] and in separately managed accounts.
What's your investment process for the fund? The style is growth at a reasonable price [GARP], so we look for those companies that show superior growth, but we pay attention to valuation, so on average we're structuring a portfolio where the growth is much higher than that of the average mid-cap company, but where the price/earnings ratio is only at a small or reasonable premium to the S&P 400. Our stock selection efforts are complemented by portfolio risk controls that control and moderate our tracking error, sector bets, individual stock bets, and also the weighted average capitalization of the portfolio, so that a lot of those large, macro bets are somewhat neutralized, and therefore driving all of the alpha generation to stock selection.
What do you mean by "neutralized"? Our targeted tracking error is 5% to 5.5% relative to the benchmark, and the individual sectors cannot deviate from the benchmark by more than 300 basis points. So, if a sector in the benchmark has a 10% weighting, then our portfolio can go up to 13% in the sector, or we can have as little as 7% in that sector. What these risk controls do is to make sure that good stock selection is not somehow dominated by one of these other factors. At the end of the day it ensures a certain amount of exposure to the mid-cap core or mid-cap growth part of the market.
So alpha and beta? Correct. The risk controls ensure the exposure in the beta; the alpha comes through stock selection. We just think that's more repeatable, so the selection doesn't come from a once-in-a-lifetime market-timing call, [or] what could be considered very aggressive sector bets; it comes from a diversified portfolio of growth stocks that have the characteristics that we like to see, and ultimately the probability of repeating past success is higher.
Do you use quantitative modeling? Yes, we use a multifactor model that helps us rank the stocks in our universe, stocks that range from $500 million to $10 billion of market cap, roughly 2,500 names, so the quantitative modeling helps us identify those stocks that look the most attractive. We'll screen for the rate of earnings growth, acceleration in earnings growth, companies that are beating estimates, high return on invested capital, expanding growth margins, and valuation–those [are] some of the factors that we look at. We look at valuation a lot of different ways too, not just price-to-earnings ratio, but price-to-sales, enterprise-value-to-cash flow, and a few others, too.
Can you talk about some of your largest holdings? Let's talk about a company called Blackbaud (BLKB). It sells software [that] helps nonprofit organizations improve their fundraising efforts, and helps with the accounting and the back-office work. Nonprofit organizations have been kind of slow at adapting technology, and the value proposition from Blackbaud's software is extremely compelling, and Blackbaud dominates in that part of the market. So we have a company with dominating market share, with a very clear value proposition in a very underserved, under-penetrated market. It's probably a mid-teens grower, and they generate a lot of free-cash-flow.
