Fund in Focus: Constellation Sands Capital Select Growth

Frank Sands Jr., manager since July 2000S&P Rank: 3 StarsBulking Up On Biotech

Aug. 16, 2004 -- Funds that invest in growth stocks of large companies often own big makers of brand name drugs.

Don't look for any in the Constellation Sands Capital Select Growth Fund (PTSGX), though. Two of them left the portfolio not long ago.

As an alternative, portfolio managers Frank Sands Jr. and David E. Levanson have bulked up on biotechnology companies and medical device manufacturers, which together account for about 25% of the fund's assets that total $97 million. The stockpickers say those are the areas where they're finding the most innovation in the health care sector, and hence the fastest growth.

For example, in May, the fund invested in Teva Pharmaceutical Industries Ltd. (TEVA), an Israeli biotech company that produces generic drugs. Levanson thinks it can fatten its bottom line by 24%-25% for the "next several years." Sands expects Teva to benefit down the line as consumers and the health care industry embrace less costly generics.

Another biotech stock, Genentech Inc. (DNA), is one of the fund's top holdings. The managers say they own the company because, among other things, it produces three leading cancer treatments (Rituxan, Herceptin and Avastin). They expect Genentech to generate earnings growth of more than 25%.

The fund also has stakes in biotech drug makers Allergan Inc. (AGN), Amgen Inc. (AMGN) and Genzyme Corp. (GENZ); and medical device makers Medtronic Inc. (MDT) and Stryker Corp. (SYK).

In May, the managers unloaded Pfizer Inc. (PFE), and a month later they moved out of another big traditional drug maker, Johnson & Johnson (JNJ). Both were disposed of because the managers felt the companies' revenue and profit growth would slow in coming years.

Sands and Levanson will sell a company whose financial fundamentals appear to be slipping, or if it loses its industry leading position. Stocks with excessive valuations will be banished from the portfolio as well.

Companies that make their way into the fund tend to stick around, however. The managers look to hold stocks for five years or more. Their long-term approach to investing is illustrated by the fund's turnover rate, which clocked in at 28% last year, compared to 94.5% for the average large-cap growth fund.

Returns for the four-year-old fund, on the other hand, have outpaced its peers lately. The fund was up 5.7% this year through July, versus a loss of 3.1% for its peers. For the one year period ended in July, the Constellation offering gained 15.4%, versus 7.1% for its peers. However, it has assumed more risk, based on its higher volatility rating. The portfolio's higher beta means that it is more sensitive to changes in the market.

The fund, formerly called the Pitcairn Funds Select Growth (PTSGX), recently joined the Constellation group, which retained the fund's portfolio managers. The expense ratio for the retail version of the fund, which Pitcairn had capped at 1.15%, has risen to 1.35% under Constellation, but the company expects it to decrease by five to 10 basis points over the next six to eight months as the fund's assets increase. The average large-cap growth fund charges 1.52%.

When it comes to buying, Sands and Levanson want big companies whose bottom lines are expanding, and that they think can sustain fast paced growth. "Large-cap growth is all we do here," Levanson says of Sands Capital Management Inc., which runs the fund for Constellation. "The whole firm's focused on it."

The stocks in the portfolio are expected to increase earnings by 22%-23%, on average, over the next three to five years, Levanson says.

In addition, the managers favor companies with strong cash flow, low debt, and leading positions in industries that appear poised to prosper.

As for valuations, Levanson says he and Sands are "willing to pay a premium for what we consider to be a premium business." To keep the portfolio's price multiples in check, the managers say they keep another chunk of their holdings in stocks that trade at a discount to the market.

The pair limits the portfolio to 25-30 stocks. That number provides adequate diversity while making it easier to research companies. Increasing the holdings would mean "you're owning worse businesses," Levanson says.

Another stock that entered the portfolio this year is Apollo Group (APOL), which provides college courses to working adults. The managers invested in the company in February, and it's now one of their top five stocks. Apollo, the leader in its field, features solid returns on invested capital and no debt, according to Levanson. He expects the company to churn out earnings growth in the 30% range over the next five years.

Apollo's stock and shares of similar companies weakened earlier this month after Corinthian Colleges (COCO), which provides post-secondary educational programs, issued a discouraging forecast. But Levanson and Sands maintain that Apollo's course offerings differentiate it from its competitors. Because of that, and Apollo's position in the industry, they remain optimistic about the stock.

A dominant franchise is one of the things the managers say they like about online auctioneer eBay Inc. (EBAY), the fund's No. 1 stock currently. The managers expect the company's earnings to jump by 40%-45% annually over the next five years as it attracts new users and increases the kinds of products it sells.

Sands cites coffee shop chain Starbucks Corp. (SBUX) as as a stock he especially likes. The company essentially created a market for specialty coffee that did not exist previously, and now leads it, Levanson says. "Our favorite way to describe this company is to say they sell sugar and caffeine at 60% margins," he adds.

Contact Robert F. Keane with questions and comments at: bkeane@investmentadvisor.com.

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