Rich Pzena, manager since 6/96

S&P Rank: 5 Stars

Hard Bargaining

Aug. 21, 2003 — Deep value investor Rich Pzena believes it’s difficult to find steep bargains in any market climate. “You can’t buy the fastest businesses with the best growth rates because they don’t sell at the best prices,” Pzena says.

Despite these pitfalls, Pzena has achieved enviable results running J Hancock Classic Value/A (PZFVX). The fund is the second best-performing mid-cap value fund for the three years through last month, gaining 16.9%, on average, versus a 6.7% rise for its peers. The fund is also holding up well of late with a 17.2% gain this year through July, versus 15.8% for its peers.

Pzena says he invests with “a fairly heavy dose of realism,” which includes several steps. First, the manager looks for companies with some difficulties. Next, he asks three questions: Are the difficulties temporary? Does the company have a good business? Will the company’s earnings improve significantly down the road?

Fundamental research is key to Pzena’s strategy, but he also uses other criteria. “Research is only half the battle,” he says, because investing is “an emotional business.” Pzena ranks each potential holding from the cheapest to the most expensive based on the ratio of its current stock price to its projected earnings. He only buys stocks in the cheapest quintile of this ranking.

Pzena automatically sells a holding when it reaches the midpoint of the ranking system. The manager says following this automatic sell policy can be difficult because stocks are often doing well at the halfway point in the ranking.

Despite his detailed process, Pzena says no investment process is perfect. “You can’t avoid the value traps,” he says. The key is recognizing mistakes and moving on, he adds. “If a stock blows up, you need to be flexible and sell.”

Pzena feels a portfolio of 25 to 40 works best for the $100 million fund and the $4 billion in assets he manages overall. He aims for an average holding period of three years.

The fund’s largest sector currently is financial services, particularly insurance and mortgage-related companies. A key holding is Freddie Mac (FRE). Pzena is not concerned about the company’s accounting difficulties, as he feels it is likely to restate its earnings higher.

As of July 31, the fund’s largest holdings were Boeing Co. (BA), CIT Group (CIT), Computer Assoc Intl (CA), and Hewlett-Packard (HPQ).

The predecessor fund to John Hancock Classic Value was Pzena Focused Value Fund, which became part of the John Hancock fund complex in November, 2002.