Primecap: The Best Stock Pickers You've Never Seen
The men who run the Primecap funds are so under the radar we couldn’t even find their pictures. And that’s just the way they want it.
The sun was setting on a warm fall evening when the guests sat down for dinner in the boardroom of the Vanguard Group’s Malvern, Pa., campus. The attendees, executives and board members of the giant fund complex and the principals of Primecap Management Co., visiting from Pasadena, Calif., were celebrating the 30th anniversary of Vanguard Primecap Fund. And what a fund worth toasting: A $10,000 investment in Primecap three decades ago would be worth nearly $500,000 today, more than double what you would have earned in an index fund that tracks the overall stock market. “That’s stunning wealth accumulation for investors,” says Dan Newhall, a Vanguard principal who attended the dinner.
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And yet Primecap Management, the adviser behind the fund, is hardly a household name. That’s partly by design; the firm rarely, if ever, talks to the press. We can’t say it declined our request for an interview because we never got far enough to ask. The firm’s receptionist said she had been instructed not to pass along any calls or messages from reporters. Photos of the managers seem to be nonexistent; a Google search for images turns up zilch. It’s as if the firm’s leaders were hiding under Harry Potter’s invisibility cloak.
The mystery grows when you learn that the four men who run Vanguard Primecap—Theo Kolokotrones, Joel Fried, Alfred Mordecai and M. Mohsin Ansari—also manage five other top-notch funds. But only two, Primecap Odyssey Growth (POGRX) and Primecap Odyssey Stock (POSKX), are open to new investors, though the well-heeled clients of Vanguard Flagship and Vanguard Asset Management Services can open accounts in the three Vanguard-labeled Primecap funds: Primecap, Primecap Core and Capital Opportunity.
All told, Primecap manages $77 billion in mutual funds, plus $17 billion more in pension and endowment money for big outfits such as General Motors and the Metropolitan Museum of Art. But it isn’t gunning for more assets. The firm has 25 clients, and it is not eager to acquire more. “The managers want to limit the number of clients they have to a manageable number so they don’t have to deal with a lot of client interaction and sales-type stuff, because that would be a distraction,” says David Kathman, a Morningstar analyst who has followed the firm and its funds since 2006.
How they do it. And that’s just as well. Instead of building an empire, Primecap’s leaders focus on building wealth for their clients. They do this by applying the same strategy to all of their funds: Invest in growing companies that trade at bargain prices. And they look for a catalyst—say, the introduction of a new product, arrival of new executives or a restructuring—that they think will push a stock higher over the next three to five years. “The managers are buying stocks that other people are selling,” says Dan Wiener, editor of the Independent Adviser for Vanguard Investors newsletter and a longtime Primecap fan (see Why Vanguard's Actively Managed Funds Are a Better Bet).
Primecap’s founders learned the process at Capital Group, the publicity-shy firm behind the American Funds. The trio—Howard Schow (who died in 2012), Mitch Milias (who stepped down from day-to-day management duties in 2014) and Kolokotrones—left Capital Group in 1983 to start Primecap Management.
Their strategy has produced strong long-term results. Thanks largely to health care stocks bought on the cheap in the mid 2000s, every Primecap-managed fund landed in the top 20% of its peer group over the past five years through November 4. Vanguard Primecap was in the top 9% of funds that focus on large, growing firms; Primecap Odyssey Aggressive Growth, which is closed to new clients, landed in the top 1% of funds that concentrate on growing midsize companies.
The firm’s 2014 results have been especially impressive. In a year when most actively run funds have lagged the broad market, Primecap’s managers have shone. Five of the firm’s six funds beat Standard & Poor’s 500-stock index year-to-date through November 4. A hefty weighting in the stock market’s top-performing sectors in 2014—health care and technology—boosted results. So did some smart bets on airline stocks. Odyssey Growth lagged by a smidge, and that’s because it skews more toward small and midsize companies, which trailed their big-company brethren in 2014.
In the end, patience may be the key to Primecap’s success. The firm’s biggest fund, Vanguard Primecap, with $45 billion in assets, has a turnover ratio of 5%, which means stocks stay in the fund for 20 years, on average. By contrast, the typical large-company fund has a turnover ratio of 62%, suggesting an average holding period of 19 months.
Big winner. The Primecap team first invested in Biogen, a biotech firm, in 2003. (Biogen would soon merge with Idec Pharmaceuticals.) The stock was down 50% from its all-time high at that time of about $70. Thanks to its effective treatments for multiple sclerosis, Biogen Idec (BIIB) has prospered, and its stock has climbed 850%, to $322. It is now one of the five biggest holdings in four of the funds.
Another long-term holding, BlackBerry (BBRY), hasn’t been as successful. Odyssey Aggressive Growth invested in the phone maker in 2005, when it was known as Research in Motion. The shares performed well for a few years but have been awful since 2008, plunging 96% from peak to trough. Manager Fried was “beside himself for having so much money in the stock when it was in the toilet,” says Wiener. But Fried’s bet that text messaging in the developing world would revive BlackBerry has begun to pay off, and the stock soared 41% in the first 10 months of 2014.
In addition to low turnover, all Primecap-managed funds share some other traits. Annual expense ratios of between 0.45% and 0.65% are well below average. Each fund holds 130-odd stocks, and at least half of each fund’s assets are currently invested in a combination of health care and technology companies.
But the funds have slightly “different flavors,” says Vanguard’s Newhall. Of the two Odyssey funds still open to new investors, Growth is more aggressive than Stock. One-third of Growth’s assets are in small and midsize companies, compared with 20% in Stock. Growth’s holdings are expected to generate slightly faster earnings growth than Stock’s.
Recent years have seen change at the top, with Schow’s death and Milias in retirement. But the firm is grooming new talent. It hires one or two new analysts a year—most from elite colleges and business schools, such as Harvard and Stanford.
In their understated offices in Pasadena (the firm only recently replaced decades-old conference room chairs), managers and analysts meet each morning to discuss news on portfolio holdings. They also meet after the market closes on Tuesdays and Fridays to discuss all of their holdings.
But the funds are not run by consensus. In fact, Primecap avoids groupthink: Each portfolio manager runs his own portion of each portfolio independently. The 13 analysts—three are women—manage 5% of each fund. Prove yourself a good stock picker and you’ll get bigger bonuses. And eventually you’ll move up—like Ansari, who became a comanager in 2007 of the Vanguard-labeled funds. These days, says Morningstar’s Kathman, all eyes are on an analyst named James Marchetti, a graduate of the Massachusetts Institute of Technology who joined the firm in 2005 and is behind the selection of many of the biotech stocks that have boosted the funds’ results in recent years.
But performance has no impact on the fees that Primecap Management collects for running its six funds. “Primecap is paid a percentage of assets, period,” says Wiener.
Regardless, the firm is doing just fine. Wiener estimates that Primecap earns about $128 million a year in fees from the Vanguard funds alone. It’s an impressive number, especially when you consider that Primecap’s leaders initially rejected Vanguard’s invitation to start a fund. The story goes that in 1983, when Vanguard founder John Bogle offered Primecap the chance to run a Vanguard fund, the firm said no. Luckily for future investors, Primecap changed its mind.