A Red Hot Momentum Fund
The past year was a trying one for many fund managers. Not for John Small, though. His American Century Legacy Focused Large Cap fund camped out at the number-two spot among all diversified stock funds -- behind only the legendary Ken Heebner's CGM Focus, a member of the Kiplinger 25.
Although the two men share the honor of market-trouncing returns, they arrived at their gains -- CGM Focus (symbol CGMFX) soaring 80% and Legacy Focused (ACFOX)returning 47% for the calendar year -- by very different tacks.
Heebner runs his flexible go-anywhere fund by making big-picture calls on the economy and sectors and trading at a breakneck pace. Small, on the other hand, follows a rigid computer-driven process to construct his fund's $39 million portfolio.
Momentum is key for Small. No surprises there, as American Century pioneered momentum-driven investing, or buying stocks experiencing rapid price and earnings appreciation, decades ago with its Growth and Select funds when the family was called 20th Century. The specifics of Legacy Focus's computer models are proprietary, but the most important factors it weighs are quarter-over-quarter earnings and revenue growth, as well as share-price momentum. The model also factors in earnings estimates, rewarding companies whose profit growth is expected to accelerate.
Small's computer ranks the largest 70% of U.S.-traded companies (including foreign issues). He sells any stock that has dropped to the bottom 50% of names, reinvesting the proceeds in new companies that crop up in the top 10%.
He lets winners run; he won't sell off a holding in the top 50% just to make room for a new stock he likes. "I don't blindly follow the computer -- there's always a pilot monitoring the autopilot," he says.
The fund returned 30% annualized from its inception in May 2006 through January 4, more than tripling the 9% annualized gain of Standard & Poor's 500-stock index over that period. When the S&P 500 plunged 9.4% from October 8 to November 26, Legacy Focus contained losses to 3.6%.
For their strikingly different approaches, Legacy Focus and CGM Focus have a lot in common. Small's fund held just 30 stocks at the end of September, the most recent date for which complete portfolio data are available. Eight of those overlapped with Heebner's 23 stock holdings as of the same date.
Like CGM Focus, Small's fund benefited in 2007 from little exposure to financial companies. They made up between 0% and 6% of the fund's portfolio over the course of the year, he says.
More cyclical industries such as materials supported the fund's dazzling returns in '07. Top-ten holding Companhia Vale do Rio Doce (RIO), a Brazilian mining company and a Heebner pick, gained 49% in the third quarter alone.
Phoenix-based Southern Copper Corp. (PCU), which mines copper in Peru and Mexico, rose 42% that quarter. Telecom holdings, such as blackberry maker Research In Motion (RIMM), also gave a strong showing.
Small expects his momentum strategy to continue to deliver in 2008, particularly if the big, fast-growing companies he tends to gravitate to remain in favor. "Even in a down market we'll always be migrating to the best relative strength," he says.
He says "growth is still there" in foreign materials companies and anticipates that some beaten-down financial names will rebound strongly in the second half of '08. Legacy Focus could continue it's winning streak into 2008 if the market continues to reward fast-growers, but it's aggressive tactic and concentrated structure could lead it to stumble extra hard if investors change course.
Small has been with American Century for 17 years, giving him much time to see the firm's momentum strategy in action. He manages four other funds with similar quantitative approaches, although Legacy Focused is the most concentrated. American Century Legacy Focused charges 1.10% in annual expenses and requires a $2,500 minimum initial investment.