Finding Opportunities When Other Investors Are Pessimistic
Many investors found it hard not to break into a double sweat over the steamy summer as the stock market plummeted 17% from its July peak to its trough one month later. Not the managers at BBH Core Select (symbol BBTEX), a member of the Kiplinger 25. "When things look bleak and others are pessimistic, that’s the kind of opportunity we thrive on," says Michael Keller, one of the fund's three managers.
In fact, investors have had plenty such “opportunities” lately. From April 29, when the bull market reached its acme, through August 29, Standard & Poor’s 500-stock index dropped 10.6%. BBH Core Select fared better, losing 7.3% over the same period.
Holdings in Visa (V), the credit-card company, and makers of consumer necessities, such as Nestlé (NSRGY.PK) and Coca-Cola (KO), helped BBH hold down its losses. “These businesses have a good mix of geographic and currency exposures,” says Keller. But the fund’s exposure to financials -- 24% of the portfolio, including insurers Chubb (CB) and Progressive (PGR) -- hurt performance.
Even so, the managers took advantage of the market dip and added three new companies to the fund, including two banks -- Wells Fargo (WFC) and U.S. Bancorp (USB). They also stepped out of two positions, including W.W. Grainger, the industrial equipment and tool company, because the stock had reached what the managers determined was its intrinsic value (their determination of the company’s actual worth). Keller thinks that’s a lot of change for a concentrated portfolio like BBH Core Select, which holds just 30 stocks, each for an average of three to five years. “In any given year, we have three or four entry or exit positions,” he says, “and here we’re not even through three-quarters of the year yet.” (Keller declined to disclose the names of the other stocks because he was still in the process of buying one and selling the other.)
Keller, who joined the fund in 2008, and his cohorts Richard Witmer and Timothy Hartch, who have been on the team since 2005, are disciplined investors with a long-term view. They look for growing companies that are leaders in their industries with proven competitive advantages and that have solid management at the helm (if that sounds similar to Warren Buffett’s strategy, you’re onto something -- the fund’s top holding is Berkshire Hathaway A, which trades under the symbol BRK.A). Then they carefully examine how a company’s managers run the store. Companies with conservative balance sheets, strong free-cash flow generation (the amount of cash profit left after accounting for the capital expenditures needed to maintain the business) and high returns on invested capital make the shortlist.
But only those companies that trade at a discount of 25% or greater to the managers’ estimate of intrinsic value make it into the portfolio. Buying at a discount allows the managers to sit back during brief market surges -- and downdrafts. The stocks may move, but “the underlying business value of the company is less volatile than the market,” says Keller, adding that this approach “allows you to be more objective and calm in markets like this.”
Their stick-with-it investing style hasn’t hurt the fund during down periods: In addition to losing less than the market during the recent correction, BBH held up relatively well during the 2007-09 bear market. During that calamity, the fund surrendered 41.1%, compared with a 55.3% decline by the S&P 500. The fund’s ability to hold down losses during treacherous markets has helped produce a stellar five-year return. Through August 29, the fund’s class N shares, which require a $10,000 minimum, returned 6.1% annualized, beating the S&P 500 by an average of 5.5 percentage points per year and the typical large-blend fund by an average of 6.0 points per year. Core Select also offers a retail share class (BBTRX), which has a $5,000 initial minimum but slightly higher expenses.