Fly to Quality on These Funds

Spiros Segalas, manager of Harbor Capital Appreciation, thinks the flight to quality that's occurred in the bond markets is rubbing off on stocks. Investors are starting to remember that "there's nothing like investing in strong companies with strong balance sheets," he says.

That's good news for Segalas, who has stayed true to his mission of investing in large, resilient, fast-growing companies despite their relegation to the B-list over most of the past seven years. But there has been a significant shift in 2007. Year to date through August 17, stocks of large growth companies have trounced shares of small, undervalued companies by eight percentage points.

Valuation is on the side of large-cap growth stocks. Ron Canakaris, who has managed Aston/Montag & Caldwell Growth for 13 years, says that relative to the overall market, the 25 largest companies in Standard and Poor's 500-stock index are trading at their lowest price-earnings ratios in 20 years.

Canakaris thinks the U.S. economy is heading for a tougher period, one in which only the strongest companies will be able to sustain high earnings growth. But other nations will continue to generate superior growth, he says. Half of the revenues of the companies in his fund come from outside the U.S. Such companies as General Electric (symbol GE) and Schlumberger (SLB), the fund's second and third largest holdings, respectively, will benefit directly from the growing need for infrastructure around the world. And Canakaris' fourth largest holding, Procter & Gamble (PG), stands to benefit from growing wealth around the globe, particularly in emerging markets.

Canakaris holds a concentrated portfolio of about 35 names. Potential investments must pass a litmus test of long-term and near-term earnings growth and generally must sell at a 10% discount to his team's estimate of their intrinsic value. Today the portfolio, on average, is trading at a 20% discount to intrinsic value, Canarkaris.

Segalas has a similar, if slightly more aggressive, approach for Harbor Capital Appreciation (HACAX). He snaps up shares of large companies with accelerating sales and earnings growth. Segalas, who has managed the Harbor fund for 17 years, particularly likes companies that combine these aggressive characteristics with defensive features, such as strong brands and a global presence. "I look at our portfolio and my mouth waters," Segalas says. "These are very strong companies."

Because Harbor owns a number of high-flying tech stocks-among them Google (GOOG), Adobe (ADBE) and Apple (AAPL) -- the fund feels the surges and swoons of that high-octane sector. Segalas realizes that his fund will take its share of lumps if the present correction continues. "We'll get battered along with the rest because these things always tend to get overdone," he says. But he thinks his holdings will show resilience, particularly in comparison with companies that have to rely on a fecund economy to generate earnings growth.

The long-term performance of both Harbor and Aston/Montag & Caldwell is uninspiring. Harbor Capital Appreciation returned 5.2% annualized over the past ten years through August 17, while Aston/Montag & Caldwell (MCGFX) gained 4.5% annualized. Over that period, the S&P 500 returned 6.5% per year compounded. But their experienced management teams and time-tested disciplines will be a boon if the shift toward large-company growth stocks continues to play out.