It’s hard to find fault with FBR Focus (symbol FBRVX). From its launch in December 1996 through October 8, the fund, which invests in small and midsize companies, returned an annualized 12.5%. That trounced the Russell 2000 Growth index (a measure of small, fast-growing companies) by ten percentage points per year, on average, and edged Standard & Poor’s MidCap 400/Citi Growth index (a similar barometer of medium-size firms) by one point per year. Moreover, despite allotting nearly two-thirds of assets to its ten biggest positions, the fund achieved those impressive returns with less volatility than the indexes.
The fund is the brainchild of Chuck Akre, whose firm ran FBR Focus from its launch until last August. At that point, Akre quit and started his own fund, Akre Focus (AKREX). The three new co-managers of FBR Focus -- David Rainey, Brian Macauley and Ira Rothberg -- all served as analysts at Akre Capital before switching allegiance to join FBR.
Not surprisingly, Akre and his proteges go about their stock-picking chores in similar fashion. They seek small and midsize businesses that produce high and sustainable returns on equity (a measure of profitability) and have the ability to generate earnings growth of at least 15% annually over the long haul. The aim is to purchase stocks of these “compounding machines,” as Akre calls them, at attractive prices and hold tight for many years.
Akre and his students describe the process as a three-legged stool. First, they identify businesses with a strong competitive advantage and the ability to produce copious amounts of free cash flow. Next, says Akre, they ascertain whether these businesses are run by managers who “conduct business with integrity and act in the interests of shareholders.” The final leg is to determine whether those managers have abundant opportunities to plow excess cash back into expanding the business. Says Rainey: “We hunt for elephants, not rabbits.”
Competitive advantages often derive from valuable licenses or patents, or a superior distribution network. For instance, FBR’s largest holding, American Tower, is the leading operator of cell towers for the wireless-phone industry. Rainey calls these towers “vertical real estate” because they benefit from long-term contracts with built-in price escalators and are shielded from predators by zoning barriers. So we’re faced with the dilemma of picking between two fine funds, FBR Focus and Akre Focus, that are run on identical principles. Akre’s successors at FBR are no doubt talented analysts with much potential as fund managers. But fund management is all about instincts and skills that have been honed by years of experience. Unlike an NFL running back who peaks in his twenties, managers tend to improve with age -- unless they burn out, get too greedy or lose their wits.
So, we’ve decided to replace FBR Focus in the Kiplinger 25 with Akre Focus. Annual fees for both funds’ low-minimum share classes are so close -- 1.43% for FBR, 1.49% for Akre -- as to be a nonissue. But longtime investors in FBR Focus who are sitting on large capital gains in taxable accounts should consider holding on to their shares.