Aug. 12, 2004 — In the early 1960s, the Chicago Cubs baseball club instituted a “college of coaches,” instead of having just one manager. It was done in order to turn that franchise around, but was a disaster, resulting in more last place finishes for the woebegone team.
In mutual fund investing, however, the multi-manager approach can be quite successful. Consider American AAdvantage Large Cap Value Fund/AMR (AAGAX), which is co-managed by a team of four subadvisors working independently of each other.
For the year ended July 30, the $730-million fund gained 22.1%, beating both its benchmark, the S&P BARRA 500 Value Index, which rose 10.2%, and the average large-cap value fund, which rose 17.3%. Over the longer-term, the fund has handily beaten its bogies. For the three-year period, the fund rose 5.2% annualized, versus an average 0.4% return for the peer group, and a 0.6% drop in the index. For the five-year period, the fund climbed 4.1%, compared to a gain of 1.5% for its peers, and 0.4% for the Index.
Launched in July 1987 as one of American AAdvantage’s four flagship funds, the Large-Cap Value fund is currently managed by Hotchkis and Wiley Capital Management LLC; Barrow, Hanley, Mewhinney & Strauss Inc.; Brandywine Asset Management LLC; and Metropolitan West Capital Management LLC, all of whom are value specialists. AMR Investments, a wholly owned subsidiary of AMR Corp. (AMR), the parent company of American Airlines Inc., oversees the four subadvisors.
The four money managers operate with autonomy and independently of each other. However, they must abide by some basic principles of value investing established by AMR Investments. In addition, they are evaluated quarterly to assure that they adhere to the fund’s investment guidelines, and their performance is also monitored.
“The subadvisors are required to invest in stocks with a minimum market-cap of $1 billion, in the range of the Russell 1000 Index, and with P/E ratios below the market and forward growth rates above the market,” said William F. Quinn, President of both AMR Investments and the American AAdvantage Funds. “Moreover, they cannot have more than a 30% exposure — or the index weight, whichever is larger — to any one sector; or more than 5% in any individual holding.” Once those criteria are satisfied, the managers have wide latitude in stock selection.
Hotchkis and Barrow have been with the fund since its inception. Brandywine joined eight years ago, and Metropolitan came aboard almost four years ago. In searching for managers, AMR looks for good long-term performance, and a historically consistent style. “Typically, before we give a subadvisor one of our mutual fund products to run, they have experience with managing some of our pension finds,” Quinn said. “Barrow, for example, has been managing money for American Airlines’ pension funds since 1980.”
As of June 30, 2004, the fund’s top ten holdings were Bank of America (BAC), 2.6%; ConocoPhillips (COP), 2.3%; Tyco International (TYC), 2.2%; Altria Group (MO), 2.1%; Boeing Co. (BA), 1.9%; Citigroup Inc. (C), 1.8%; Cendant Corp. (CD), 1.8%; MetLife Inc. (MET), 1.8%; Allstate Corp. (ALL), 1.7%; and J.P. Morgan Chase & Co. (JPM), 1.5%.
Quinn estimates that among the 162 stocks in the fund as of June 30, only about 30 to 40 overlap, but not in all four portfolios. “It is rare for a stock to be owned by all four subadvisors at any one given time,” he said. “Thus, we can always provide diversification.”
The fund’s largest sector, financials at 28.2%, represents an underweighting relative to the index (36.5%). Also, relative to the index, the fund has a lower P/E ratio (14.4 versus 15.0), and significantly lower five-year earnings growth rates (4.2% versus 6.7%), reflecting the fund’s deeper value approach.
Quinn attributes the fund’s outperformance to astute stock picking, but also to the managers’ strict adherence to a value discipline rather than chasing returns. “In 1998 and 1999, many value managers bought growth stocks, but our managers underperformed because they stuck to value names,” he noted. “By 2001 and 2002, however, we outperformed because the overall market became weaker.”
There hasn’t been any turnover among the senior portfolio managers of any of the subadvisors during their tenure on the fund, which is part of the consistency that Quinn says he looks for. He also likes subadvisors who invest for the long term. As a result, the fund typically has low turnover, generally between 25% and 33% per year, far below the peer group.
Although the four subadvisors are all firmly in the value camp, there are some subtle differences between their philosophies, Quinn noted. “Barrow adheres to a classic Graham-Dodd fundamentals-based management style,” he said. “Hotchkis has historically focused on dividends; and Metropolitan West has a tradition of looking for value in sectors that are regarded as more growth oriented, like technology.”
As of June 30, 2004, Hotchkis held 30.7% of the fund’s total assets, Barrow had 28.9%, Brandywine held 27.8%, and Metropolitan, 12.6%. “The minor differences between the first three allocations reflects variations in price performance and some cash flow movements,” Quinn said. Metropolitan West has a smaller stake because it joined the fund much later than the other three. “When they initially joined us, Metropolitan West’s performance was somewhat spotty, but has recently gotten much better,” said Quinn. If we were to start a new fund now, each subadvisor would, of course, be equally allotted 25% pieces of the fund.”
The fund’s sell discipline typically relates to valuation concerns. While AMR Investments does not order subadvisors to dispose of certain stocks, they are strongly encouraged to reevaluate a company once it reaches a P/E ratio above the overall market.
The AMR share class, which is used only for AMR employees’ 401(k) retirement plans, has an expense ratio of 0.39%. The Institutional Class, available to corporate clients, broker-dealers, and advisers, carries a 0.66% expense ratio. The third share class of the fund, called PlanAhead, is available to all investors for individual accounts. The PlanAhead class requires a $2,500 minimum initial requirement and has an expense ratio of 0.95%, versus 1.39% for its peers.
Contact Robert F. Keane with questions or comments at: [email protected].