Investec American fund is better than it looks at first glance

Chetan Modi, fund analyst at Morningstar, comments: This Investec fund, launched in September 2002, benefits from a very experienced management team. It is run by Thornburg Investment Management in the USA and is a near-clone of their Thornburg Value fund. Investec American is co-managed by William Fries, Connor Browne and Edward Maran; Fries is a seasoned investor with over thirty years experience and has managed Investec American since launch in 2002. In February 2006 Browne and Maran stepped in as co-managers and the fund is now run using a team approach. Brown and Maran are both experienced campaigners and have been with Thornburg in associate portfolio manager roles since 2001 and 2002 respectively.

We think the strategy deployed by the managers is fundamentally sound. They search for companies that are trading at discounts to their intrinsic values by unearthing stocks that have attractive valuations, improving fundamentals and are able to offer a yield. The managers split their portfolio into what they believe are three types of value stocks: basic value, consistent earners and emerging franchises. Although the fund is laden with stocks that the managers define as basic value (such as Exxon Mobil) and consistent earners (Microsoft), the exposure to emerging franchise stocks, such as Apple (usually between 10-15% of the portfolio) gives the fund a growth tilt. There is also some notable exposure to smaller-cap stocks - the fund currently has just over twice the exposure in small-caps when compared with the average fund in the Morningstar US Large Cap Growth category.

The managers build a concentrated portfolio of 40-50 stocks with between 30-40% of assets in the top ten holdings. This introduces some concentration risk which, along with the smaller-cap tilt, can also exacerbate risk. Indeed, the fund s volatility (as measured by standard deviation) since its 2002 inception to the end of September 2008 is higher than the category norm. Moreover, the managers are willing to take sector bets which are out of line with its peers. We think this is where they can add value but with that comes added risk if those sector bets turn sour. For example, the fund has much more exposure to financial services when compared with the average fund in the Morningstar US Large-Cap Growth category and this has hurt it as the sector has plummeted. However, the underweight in industrial materials, a sector which has also dived recently, has offset some of those losses.

These sector bets, coupled with the concentrated portfolio, can lead to bouts of underperformance in the near term but returns for the five year period to 27 October 2008 have been solid, if unspectacular the fund ranks in the second quartile of its category but has lagged its S&P 500 benchmark, as have many of the fund's peers. Nevertheless, we are confident about this fund s long-term prospects. The Thornburg Value fund, upon which this offering is based, has delivered top quartile returns for the ten years to 30 September 2008. If investors are willing to stomach periods of underperformance, we think this fund is a strong choice for long-term US equity exposure.

Strategy

The managers of this fund use a sound and consistent approach which we think will give this fund a good chance of outperforming over the long term. The focal point of Thornburg's strategy is to look for businesses that are showing signs of steady growth but are trading at discounts to their intrinsic values. The managers narrow down the vast US equity universe to around 100 to 150 stocks by highlighting those with attractive valuations, improving fundamentals and which offer some yield. The managers then construct the portfolio in three sleeves containing stocks which they define as three types of value stocks. Basic value stocks are established names that may be trading cheaply such as ConocoPhillips and Intel; consistent earners include stocks such as Microsoft and AT&T and emerging franchises are stocks that may have higher PE ratios, such as Apple, and may also be smaller-cap stocks. The emerging franchise sleeve gives the fund exposure to growing companies but also those that are lower down the cap scale. The managers will look to sell a stock if it reaches their internal price target, if the discount to its intrinsic value diminishes or if there is a change in company fundamentals.

Management

Investec Asset Management was established 17 years ago and operates as an open-ended partnership between staff and shareholders which we think can help promote loyalty amongst its employees. Indeed, Investec is still run by its founding members and benefits from stability amongst its senior personnel where the average tenure is 10 years. The investment staff are organised into small teams which focus on equities of a particular geographic region or style of stock, such as value or growth, in keeping with the approach adopted by Thornburg Investment Management. This makes Thornburg a natural choice as managers for American fund.

We believe Investec American benefits from the highly experienced management team at Thornburg Investment Management. The fund is co-managed by William Fries, Connor Browne and Edward Maran. Fries, with over 30 years' experience, had sole responsibility for the fund from launch in 2002 until co-managers Connor Browne and Edward Maran came on board in February 2006. We think support for Fries in the shape of Browne and Maran is a prudent move on behalf of Thornburg and shows good succession planning.

The managers and analysts at Thornburg are divided into two teams: value equity and growth equity. However, the teams are closely knit and all the investment professionals sit together in the same office. This set-up works well in a boutique fund shop; it can promote the informal sharing of ideas and makes for a less bureaucratic stock selection process. The three managers can also glean ideas from the four analysts in the value team who work as generalists, which adds to their research capability.

Thornburg is a boutique operation with 168 employees and is privately owned by its senior professionals. It is based in Santa Fe which is located far from financial hubs in the USA. Employees there have thus tended to make a lifestyle choice in working for the firm due to the leisure activities Santa Fe has to offer. As a result, Thornburg is able to retain staff and employee turnover is low, which promotes stability at the firm.