Quick Take: The managers who oversee the Thompson Plumb Balanced Fund (THPBX), which owns a mix of stocks and fixed-income investments, want to hold shares of growing companies. But they prefer buying them on the cheap.
Their approach to investing in debt securites reflects caution: The fund leans towards high-quality, intermediate-term corporate bonds.
The fund has outpaced its peers lately and over the long term. Thompson Plumb Balanced lost 5.7% this year through November, while the average balanced fund was off 8.5%. The fund returned 8% on average for the five years ended last month, compared with a 2.3% average gain by similar funds. For the ten years ended November 31, Thompson Plumb Balanced gained 10.6% on average, versus 7.5% for its peers.
The Full Interview:
The Thompson Plumb Balanced Fund uses fixed-income securities to hold things steady while hunting for more rewarding investments.
Owning a conservative collection of bonds enables the team that runs the fund to look "for real opportunities to make people money, and that's going to be with stocks," says lead portfolio manager Thomas Plumb.
The $129-million fund typically keeps about two-thirds of its assets in equities. Plumb and the other members of his team, David Duchow and Timothy O'Brien, seek growing companies whose shares strike them as reasonably priced.
To pick the fund's 40-45 stocks, the managers scan for businesses that consistently generate above-average earnings, and whose stocks are trading at a 30%-50% discount to what they believe the enterprise is worth. In addition, they prize industry leaders with solid balance sheets and high returns on invested capital.
Though the trio will consider companies of any size, Duchow says they have been focusing on large ones since the summer, when the soft stock market gave them a chance to go bargain hunting.
For example, in June, the trio began buying Genl Electric (GE), which now is the fund's top stock. The managers like the conglomerate's global footprint as well as its diverse businesses -- ranging from appliance manufacturing to broadcasting -- which they see as providing the tools to build up earnings. Plumb also thinks the company's GE Capital financial services unit will strengthen as the U.S. economy picks up steam.
"We think that's an attractive company that we can hold for a long period of time," Plumb says.
Plumb cites drug distributor McKesson Corp (MCK), the fund's fifth-largest stock holding, as the kind of company he and his colleagues like. The managers say they bought a stake in the company, which also manages computer systems for health care concerns, in July.
McKesson's top line has been expanding by 12%-14% annually, and it looks like its rate of return on invested capital will be in the "high 20s for at least the next few years," Plumb says. The stock also stands out because its price-to-earnings multiple of about 14 is significantly better than those of McKesson's competitors, according to Plumb.
Overall, health care stocks account for 26% of the fund's stocks. Within this group, the managers expect profits to improve for drug makers as increased spending on research and development translates into higher revenues over the next two years.
The fund's major holdings include pharmaceuticals manufacturer Merck & Co (MRK), which ranks fourth in the portfolio. Duchow says that although the company's earnings have been flat for the last 12-18 months, he envisions them rising to double-digits next year.
Thompson Plumb Balanced's health care stocks also include Pfizer, Inc (PFE), Wyeth (WYE), and Bristol-Myers Squibb (BMY).
Another 20% of the fund's assets are in banks and financial services companies, which they see benefitting from interest rates that are now low enough to allow them make money on loans.
In this sector, the managers added J.P. Morgan Chase & Co (JPM) this year, which now holds the No. 2 position in the portfolio. The company has been hurt in recent months because it has financed troubled companies like Enron, but the fund's managers feel Morgan's capital resources are sufficient to help it recover. Plumb thinks the company's earnings can increase by more than 50% over the next two years.
While the managers wait for the rebound, they can take advantage of the stock's 3.5% dividend yield, Plumb notes. Referring to dividend, he adds, "We're not snobs. We'll try to take our return anywhere we can get it."
Other financial stocks the fund owns include Citigroup Inc (C), FleetBoston Financial (FBF), and Cincinnati Financial (CINF).
Rounding out the fund's five largest positions is software giant Microsoft Corp (MSFT), which the managers like because it dominates its industry.
The fund's portfolio currently has about 32% of its assets allocated to fixed-income securities, consisting mostly of intermediate-term corporate bonds rated single-A or better. These kind of securities are likely to decline less if interest rates increase, he points out.
Plumb says the bond portions of most balanced funds are too aggressive. "What you don't want to do is compound your risk level with your bond portfolio," he argues.