Value Added

A Core Fund for Your Portfolio

A strong sense of ethics and a stronger track record of success make Selected American Shares a good foundation for your investments.

By Steven Goldberg, Contributing Columnist, Kiplinger.com

March 23, 2004

If you're looking for a fund to serve as the core of your investments, it's hard to imagine a better choice than Selected American Shares (SLASX).

Lead manager Christopher Davis aims to produce annual returns, on average, about two percentage points better than the Standard & Poor's 500-stock index -- a goal he has fulfilled admirably over the past ten years.

In those ten years, the fund trailed the S&P only in the bubble years of 1998 and 1999. What's more, Selected American is about 15% less volatile than the index. The fund ranks in the top 10% among large-cap blend funds over the last five and ten years. Finally, it boasts low expenses -- just 0.93% annually.

A sense of ethics

Davis, 38, is a student of value investing and just the kind of person you'd want as a steward for your money. A former seminarian, he holds masters degrees in both theology and philosophy. While he ultimately chose money management, he brings to it a sense of ethics, as well as a broad intellectual curiosity, that make him almost unique among fund managers.

In a recent conversation, he talked about a favorite poem, an online satire Web site called "the Onion," a new book called "Capital" about the American funds, and a seminar he recently attended on value investing. He also railed against the repeal of the inheritance tax -- from which he stands to benefit greatly. All the while, he displayed a remarkable modesty. He seems more eager to talk about last year's mistakes, such as Safeway, than about his winners.

Family tradition

Davis literally learned investing at his father's knee. His father, Shelby Davis, 66, who still serves as an adviser to the fund, learned from his father, Shelby Cullom Davis, who founded the Davis firm in 1969. Christopher Davis started at the firm in 1991.

The Davis philosophy is twofold:

1. Identify companies' true "owner earnings" by stripping out the accounting gimmicks in reported earnings.
2. Use these owner earnings to buy good companies at depressed prices.

Davis is patient, holding on until stocks become fully priced. Turnover averages only about 20% annually.

Selected American typically keeps about half its assets in financial stocks, which Shelby Cullom Davis dubbed "growth stocks in disguise." Financials have almost always commanded far lower P/E ratios than other businesses with similar growth rates.

What's more, Christopher Davis says, analysts still underrate the diversification one can achieve within financials, instead clinging to the outdated notion that financials all plunge when interest rates rise. "Even within insurance, life insurance is a totally different business than property and casualty insurance," he says.

Inflation outlook

What's new in the fund is that Davis and co-manager Kenneth Feinberg are buying some energy stocks. This is partly because they believe that inflation is already higher than government numbers reflect -- and will increase. But it's mainly because they think supply and demand dynamics will push prices up in this decade. Favorite stocks include ConocoPhillips (COP), Devon Energy (DVN) and Occidental Petroleum (OXY).

Higher inflation in the U.S. also means the dollar should continue its decline. "The weakness in the dollar is reflecting that we owe a lot of money," Davis says. "Inflation is the easiest way to repay that debt."

Consequently, Davis and his team "are thinking a lot about places to hide." That means bulking up on multinationals. "I love to be invested in businesses that are globally diversified." Picks include American Express (AXP); Altria (MO), formerly Philip Morris; insurance giant American International Group (AIG); and Warren Buffett's Berkshire Hathaway (BRK.B).

Market outlook

The market as a whole, of course, is much more expensive than it was 12 months ago. "A lot of things look overvalued," Davis says. "It's easy for amnesia to set in" about the bear market. If the recovery doesn't unfold as people expect, the market will turn ugly -- something we've already seen a taste of in the last several weeks.

His solution: More so than usual, avoid stocks selling at high multiples, which means, among other things, most tech stocks. "Tech is the most manic depressive part of the market." He did recently buy Microsoft (MSFT), which sells at P/E of only 19 after adjusting for, among other things, the company's huge cash hoard.

While Davis finds stocks riskier than they were a year ago, he's not bearish. But, "I'm enormously bearish on bonds." It is difficult to see how yields can go much lower. The growing economy and inflation inevitably will push yields higher.

The one negative to the fund: Davis and Co. is managing a ton of assets. Davis and his eight analysts are managing some $40 billion. Davis maintains that, given how few buys and sells the team makes, they can handle the assets.

I'll take his word on that for now. But even with slow-trading, large-cap funds, there is a point -- somewhere between about $40 billion and $70 billion -- where performance seems to drop off. I trust that Davis will close to new assets long before jeopardizing shareholder returns. After all, his family is, by far, the firm's largest investor.

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