March 12, 2004 — Yes, Salomon Brothers Srs Fds:Capital/A (SCCAX) had a “terrific” year in 2003, says Robert Donahue Jr., one of its portfolio managers. To be fair, though, he points out that the fund had some catching up to do.
The $1.6-billion portfolio lost 24.6% in 2002, trailing its large-cap value fund peers, which fell 20.1%, and the Standard & Poor’s 500-stock index, which was off 22.1%.
The fund encountered most of its problems between June and September, and excluding those months, the rest of the year “wasn’t necessarily so bad,” Donahue says. But during that stretch, all types of stocks “went down quite precipitously.” So even though Salomon Brothers Capital held a diverse group, there was nothing to cushion the fall.
Still, the fund’s decline was the only one it has suffered since 1997, and it bounced back nicely last year, rising 43.8%, versus 28.7% for similar funds, and 28.5% for the S&P 500. Salomon Brothers Capital returned 12.4% on average for the five years ended last month. By comparison, its peers were up 4.2% during that span, and the index edged down 0.1%.
In overseeing the fund, Donahue says he and Ross Margolies invest in “a mix of a lot of different things.” The blend incorporates undervalued and growth stocks of companies in all industries and of just about any size, except those with market caps of less than $1 billion. The managers also stash part of the fund’s assets in cash, and sometimes keep a bit in bonds.
For the growth component of the portfolio, the managers and their team of analysts look for companies whose earnings and sales are increasing, and that have large or dominant market shares.
“What we really focus on, on the growth side,” Donahue says, “is finding business models that really make sense, that are understandable, and that are sustainable for an extended period of time.”
When hunting for value stocks, the team keeps an eye out for a catalyst, like a new product, or a management change, that can boost share valuations.
“If you look at the performance of the fund over time, the big, big winners have been companies that we bought at a value price but that turned out to be growth stocks,” Donahue says.
One of the fund’s investments that is currently traveling from the value camp to growth territory is News Corp Ltd ADS (NWS), the Australian media and entertainment giant.
“This is a company that has historically traded at a discount to its peers,” Donahue says of the firm, whose businesses range from television broadcasting to publishing and movies. The stock has been in the fund since 1998 and ranked eighth in the portfolio at the end of last month.
News Corp. has strengthened as its investments in things like the production of programs for network and cable television have begun to pay off in recent years, according to Donahue. Going forward, he expects the company’s broadcasting distribution holdings, such as BskyB, a pay television broadcaster in the U.K. and Ireland, to help fatten earnings.
As an example of the fund’s growth holdings, Donahue cites Costco Wholesale (COST), which operates a chain of warehouse stores. The fund bought a stake in the company as a value play in 1995.
The discount retailer has been able to use its strong purchasing power to keep prices low for shoppers, Donahue says. In addition, it features “one of the most impressive and disciplined approaches” for cutting costs, and is “arguably the most disciplined of any of the retailers” the fund follows in meeting gross margin targets of about 10.6%, he says. Also, Costco’s domestic stores each typically deliver just over $100 million in annual sales, Donahue says.
The No. 1 holding in the fund at the end of February was UnitedGlobalCom Inc`A` (UCOMA), which was Salomon Brothers Capital’s top performer last year.
Donahue says he likes the company because it is the leading provider of cable television and communications services in Europe, where it operates primarily in Holland and Austria.
Another major contributor to the fund’s performance last year was telecommunications gear maker Lucent Technologies (LU). The fund still owns some Lucent convertible securities, but it unloaded the company’s common stock this year because the shares had run up.
Donahue, who joined the fund in 1998, will become its sole manager in May, when Margolies will step down to focus on overseeing hedge funds for a unit of Citigroup Inc (C), the financial services company that also offers the Salomon Brothers funds.
Although the fund is losing one of its managers, its investment strategy will not change, says Donahue, who plans to continue to remain flexible in the securities he buys and sells.
“Really, I don’t expect major changes,” Donahue says. “At the end of the day, this was, is and will be a stock picking fund.”
– Richard Diennor