FUND WATCH


Running out of Momentum

Elizabeth Ody

Driehaus International Discovery racked up great returns in 2007 but could be out of steam for the near term.



Momentum-based investing proved to be a boon for several funds in 2007. The approach, which dictates investing in companies with rapidly growing earnings and appreciating stock prices, certainly worked out for Driehaus International Discovery.

The fund, steered by Lynette Schroeder, gained 32% last year, making it the top performer among all diversified overseas funds. Long-term investors may find this risky fund appealing, but they need to be aware that when just about all stocks head down, momentum funds get clobbered.

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Driehaus, itself, has a long history with the approach. Richard Driehaus, often considered the father of momentum investing, founded his Chicago firm in 1982 to pioneer his mantra of buying high and selling higher. His team is trained to identify companies on the threshold of rapid price appreciation.

Schroeder follows a rigorous stock-picking process to hunt down winners. She invests in companies with market values of $500 million to $30 billion, which means that her universe typically includes 4,000 to 5,000 or so stocks. She screens for companies with accelerating earnings growth while also looking for any news that may positively affect a company's future profits.

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The eight-analyst Driehaus team then inspects the causes of each company's earnings growth. Schroeder and colleagues look for growth drivers that can be sustained. For example, they'd rather see profits grow because of an expanding customer base than, say, by paying off debt. "Paying down debt as a means of financial control has a finite end to it," Schroeder says.

Analysts also examine the economic and legislative outlook for a company's sector. But "85% of our time and process is focused on picking stocks," she says, rather than on big-picture calls.

Companies that make the cut are placed on a watch-list. Schroeder will consider buying a candidate when she sees price and trading volume rising. She usually holds about 30% of the fund's assets in emerging-markets stocks.

Schroeder isn't a wild trader, but she has no qualms about ditching a stock when it cools. She'll sell a stock either if trading turns tepid or if new developments signal potential earnings deterioration. On average, the fund's portfolio turns over about twice a year.

Schroeder has been with the fund only since March 2005. But from her start through January 16, the fund has gained 24% annualized, beating the MSCI index that tracks foreign companies of all sizes by 6 percentage points per year on average.

She also racked up an impressive record at her previous stint with American Century International Opportunities -- another momentum fund. In each of her three calendar years with that fund, it ranked in the top 40% of diversified foreign funds that invest in small and midsize companies.

For all her talents, there's little Schroeder can do to protect shareholders when the market's momentum is down. Year-to-date through Jan. 17, the fund has lost 14%, two percentage points worse than the average international small/midcap growth fund, according to Morningstar.

That doesn't mean that investors should jump ship, but it does drive home the point that International Discovery is an aggressive fund that may suffer dramatically when the marker tanks. Schroeder recommends that new investors stick with the fund for at least three years.

Lately, she has been moving into defensive areas, such as health care stocks. She scored in 2007 with shipping companies, such as Singapore's Cosco but says growth in the industry is beginning to taper off.

For 2008, Schroeder is excited about minerals and mining companies, which "should continue to show good results, largely driven by the demand of emerging markets." She says the BRIC countries -- Brazil, Russia, India and China -- are growing strongly enough to partially offset economic weakness in the U.S.

The $855 million fund (symbol DRIDX) charges 1.68% in annual expenses. The initial minimum investment is $10,000.




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