Quick Take: Victory Diversified Stock Fund/A (SRVEX) uncharacteristically lagged its peers earlier this year. The $1.4 billion fund was down 1.5% through the end of April, while the average large-cap blend fund was off 0.2%.

The fund had been hurt by profit taking in stocks like Alcoa Inc (AA), says Paul Danes, one of Victory Diversified’s three portfolio managers. Losses by Comcast (CMCSK) and Kroger Co. (KR), which had been winners in 2003, also weighed on the fund’s performance, he says. All three stocks are still in the portfolio, though.

But as investors have warmed up to the large-cap stocks that the fund focuses on, its returns have strengthened. This year through May, Victory Diversified rose 0.9%, compared with a 0.93% gain by similar funds.

The fund has comfortably outpaced its rivals over the long term, returning 3% and 13.3%, on average, for the five and ten years ended in May. Its peers lost 1.2% and gained 9.7% during those periods.

In picking stocks, the fund’s three managers initially decide on a sector mix. Then they look for companies with inexpensive stocks and growth potential.

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Before deciding which companies to buy, the managers of the Victory Diversified Stock Fund decide how to divide its assets among the sectors in the S&P 500-stock index. Depending on the trio’s outlook for the economy and the stock market, the weights will be between 50% and 200% of that gauge’s.

Next, the team decides which stocks to invest in, focusing on shares of large companies that are inexpensive compared with their historical valuations and that have a catalyst in place to possibly spur earnings growth. They also favor managements that reward shareholders with things like hefty dividends. The portfolio typically has 50 to 70 holdings.

“We’re trying to pick cheap stocks that we think can perform in the environment that we envision,” says Paul Danes, who helps run the fund. He and Caroline Rains joined lead portfolio manager Lawrence Babin four years ago.

In February, the fund invested in air express shipper FedEx Corp. (FDX). Investors had soured on the company because they were suspicious of its acquisition of Kinko’s, Rains says. Analysts, she says, were unsure of how that company, which operates about 1,200 copy centers that also provide business services, would fit into FedEx.

Working in FedEx’s favor, says Rains, were its operations in Asia, where the Chinese economy was booming. That led the fund’s managers to conclude the company had “good growth prospects” and an opportunity to reinflate margins, which had shrunk, she says.

Their bet on Fedex paid off today. The stock traded up $0.93 to $76.94 after the company forecast fiscal fourth quarter earnings that topped Wall Street expectations. The fund’s FedEx shares cost about $70 on average.

Another stock that entered the portfolio last quarter was Kohl`s Corp (KSS), a once highflying retailer that had come back to earth after missing analysts’ estimates along with some fashion cycles, Danes says. “They were at the wrong end of some consumer purchasing trends,” he says.

But Danes and his colleagues, who buy depressed stocks of companies they think will rebound, were confident that Kohl’s could fix its problems. The chain’s low debt also made it look good, Danes says. The average price of the fund’s shares of Kohl’s is about $45. The stock closed today at $47.54.

Another company the fund embraced when it was being shunned by investors is Boeing Co (BA), which now is its No. 1 stock. The manufacturer of commercial airplanes and defense contractor entered the portfolio in late 2001, after the Sept. 11 terrorist attacks had pummeled the airline industry and undermined the stock.

Rains sees the company benefitting from the introduction of its latest jet, the Next Generation 737, whose orders are picking up, she says. That should encourage analysts to warm up to the stock, she says.

The second-largest holding in the portfolio is Genl Electric (GE), which appeals to the managers because of its dividend yield. Also, the managers expect Boeing’s new jet to boost GE’s aircraft engine unit, which is a supplier for the aerospace company.

One of Rains’ favorite stocks is Apple Computer (AAPL), which is also one of the fund’s top holdings. She believes the popularity of the computer maker’s iPod music player could spur sales of its PCs. In addition, Danes says Apple’s stock sports a lower price-to-sales multiple than similar companies, so “we’re not paying much for a very innovative company.”

Technology stocks like Apple currently account for the biggest chunk of the fund’s assets — about 23%. The managers also include aerospace companies like Boeing as tech holdings.

The managers say their convictions are strongest in the energy sector, where they have 11% of their holdings. Danes and Rains say they expect oil and natural gas companies to prosper because of strong demand in China, and because rising energy prices should spur spending on exploration and development.

The fund’s energy stocks include BP p.l.c. ADS (BP), which ranks fifth in the portfolio. The managers also have stakes in Schlumberger Ltd (SLB) and Transocean Inc (RIG), which provide services to drilling companies.

Assessing the overall stock market, Danes says it could end the year up or down 5% from its current level. He would not be surprised if the strengthening economy and corporate profits are offset by worries about inflation and interest rates. Sentiment on Wall Street could also be dampened by uncertainty about the presidential election, oil prices and the situation in Iraq, he reasons.

“We think the bias is probably up,” Danes says of stock prices. “But we don’t think it’s up substantially.”

Contact Robert F. Keane with questions or comments at:

bkeane@ia-mag.com.