Quick Take: The SB Capital & Income/Smith Barney A (SOPAX) can invest in any kind of security anywhere around the world. The only thing it doesn't own right now is emerging market debt, says lead portfolio manager Marc McAllister.
Except for limiting holdings in illiquid securities, the fund's prospectus places no restrictions on its asset allocation. The equity portion of the portfolio includes undervalued stocks and shares of growing companies.
Smith Barney Capital & Income's returns have consistently kept it ahead of its peers. For the one-year period ended in March, the fund rose 35.6%, versus 22% for the average balanced large-cap blend fund. For the ten years ended in March, the Smith Barney fund returned 10.4%, on average, versus 8.4% for similar funds.
Though the fund's go-anywhere style and ability to change its asset allocation has made it more volatile than its static balanced fund category, investors have been rewarded for the extra risk.
The Full Interview:
The managers of the Smith Barney Capital & Income Fund can buy whatever they want to. Their investment universe encompasses, among other things, stocks, bonds, and convertible and derivative securities of businesses based in the U.S. and abroad.
"We have a great deal of flexibility to move money back and forth among different asset classes," says Marc McAllister, who heads the team overseeing the $2.1 billion fund.
Stocks and convertibles make up about 64% of the fund's total assets currently, and 28%, mostly high-yield bonds, is in fixed-income securities. Cash accounts for the remaining 8%.
McAllister, who became lead manager of the fund in May 2003, is responsible for determining how it spreads its money around. His decisions take into consideration short-term market conditions and economic factors.
McAllister personally selects about 20% of the fund's holdings, including real estate investment trusts, or REITs, and what he calls the team's "best ideas," that is, investments judged to potentially offer the greatest rewards with the least risk.
Because it is seeking yield, McAllister says the fund has been favoring junk bonds over those rated investment grade. "We think this year is one when you can collect your coupon in the high-yield market, and that's not too bad," says McAllister, who expects these securities to generate total returns of 7.5%-8% in 2004.
For the equity portion of the fund, the managers can buy undervalued or growth stocks of companies of any size. However, the fund tends to own big businesses, McAllister says, because their shares are easier to trade.
On the growth side, the managers seek companies whose profits top their competitors and, ideally, analysts' estimates. Sound or improving balance sheets are prized, too.
High dividends are not needed to gain entry into the portfolio, but speaking for himself, McAllister says he likes companies that pay them. The fund's dividend yield is 3.8%, according to Standard & Poor's data.
In assessing valuations, the managers look at the price of a stock relative to the overall market, the company's peers, and the shares' own history. They want to own stocks that are cheap based on at least two of those ratios. Additionally, team members like to spot a catalyst, like a new product or management, that can boost stocks within six to 18 months.
The No. 1 stock in the portfolio is Pfizer, Inc (PFE). Unlike other big U.S. pharmaceuticals makers, the company, McAlllister says, has a "very solid pipeline" of new drugs that he expects to enable Pfizer to generate "substantial earnings growth."
Smith Barney Capital & Income currently has 9% of its equities in energy companies, compared with a weighting of about 6% in the Standard & Poor's 500 index. The fund's investments include American depositary shares of two big integrated oil companies, BP p.l.c. ADS (BP) of Britain, and Total `B` ADS (TOT), a French company. These are among its top ten holdings.
The managers been favoring the sector because they see low supplies of oil and natural gas driving prices higher. Total and BP stand out because they have better balance sheets than their competitors and a greater ability to "find new reserves cheaply," McAllister says. Beyond that, their depositary shares trade at a discount to energy bellwether Exxon Mobil (XOM), and both sport attractive dividend yields, he notes.
Among the fund's stocks, supermarket chain Safeway Inc (SWY) ranks fourth. The company was hurt by a 20-week-long strike in California that ended in late February. Safeway has been a disappointment lately because of the labor action, and it still faces competition from retailing giant Wal-Mart Stores (WMT), which is moving to sell groceries, McAllister concedes.
Still, he says he is cautiously optimistic about the stock, which he describes as reasonably priced. He expects the pact that ended the walkout to ultimately help lift Safeway's profits and share price. "There are some lights at the end of the tunnel," he said of Safeway's prospects, "and hopefully they're not an oncoming train."
Behind Safeway in the stock portfolio is Navistar Intl (NAV), a holding company whose units make trucks and truck engines. McAllister sees the company benefitting from a surge in demand as trucking companies move to replace their aging fleets.
McAllister has handled the portfolio's REIT holdings since joining the fund in late 1999. These investments -- publicly traded companies that invest in real estate and are required to pay out the majority of their annual income through dividends -- account for about 6% of the fund's total assets, says McAllister. He explains that he likes REITs because they throw off a lot of income and help diversify portfolios because they usually don't follow the movements of other asset classes.
The fund owns REITs such as ProLogis (PLD), Alexandria R.E. Equities (ARE) and Vornado Realty Trust (VNO).
In particular, McAllister says he is very partial to iStar Financial`A` (SFI), a finance company that is taxed as a REIT, and that focuses on funding private and corporate real estate owners. The stock's dividend yield of approximately 7.1% is a bit more than iStar's peers, McAllister says. Also, the shares are trading for around 2.25 times book value, "which is not too bad," he says.
Looking at stocks overall, McAllister thinks they will end the year flat or down a bit if the Federal Reserve aggressively hikes interest rates, a move he thinks unlikely. Otherwise, rising corporate profits should help lift stocks by 8%-12%, McAllister believes. "The market is going to trade with earnings, and earnings estimates have been rising," he says.