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Fund in Focus: Hennessy Cornerstone Growth Fund

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May 1, 2003 — Neil Hennessy believes emotion can be an investor’s biggest enemy. “If emotion enters your investment decisions, you’re mostly going to lose,” he says.

To avoid emotion in investing, Hennessy uses quantitative screens to run Hennessy Cornerstone Growth Fund (HFCGX). He then holds the stocks generated by these screens until he rebalances the portfolio over a four-month period, starting each November. Hennessy believes if you “buy and hang onto quality, you’ll do fine over time.”

Staying with consistent growers is one of Hennessy’s main goals. He believes investors should focus on avoiding losses on the downside, not on how much they can make on the upside. “We don’t try to be the heroes of Wall Street,” he says.

Hennessy has had some success avoiding the downsides. While the fund’s small-cap growth peers lost 23.1% on average for the three years through last month, the fund was down a modest 0.2%, beating most of the category. This year through April 30, Hennessy Cornerstone Growth was up 5.3%, versus a gain of 4.0% for its small-cap growth peers.

To build a small-cap growth portfolio, Hennessy screens for companies with:

*Market capitalizations of at least $135 million.

*Price-to-sales of 1.5 or less.

*Higher earnings than in the previous year.

*The best relative strength over the past three-, six-, and 12-month periods.

By design, Hennessy limits his process to four quantitative screens, feeling “fewer moving parts in the formula lead to fewer opportunities for mistakes.”

As a final step, Hennessy selects the top 50 companies generated by these screens, as long as they have sufficient liquidity. He believes these steps lead him to attractively valued stocks with momentum. By screening for proven results, the manager says he finds companies with solid growth potentials, not overly-hyped prospects.

While this process hasn’t led to any noticeable sector concentrations, Hennessy says it’s sparked an interesting focus: dividend-paying stocks. After the most recent rebalancing, Hennessy says that 48% of the $458 million fund’s holdings pay some kind of dividend.

Based on this result, Hennessy believes dividend-paying stocks offer some of the market’s most promising growth prospects. Burned by corporate scandals, investors are likely to seek out companies operating under the discipline of consistently generating dividends, Hennessy says.

Focusing on dividends rather than hype also highlights Hennessy’s mantra of avoiding emotion. He believes his emphasis on dividend-paying stocks will be a sound strategy for the foreseeable future as investors, burned by deep losses, continue to avoid more speculative investments.