Bedrock Value

There have been a lot of rumblings in the last few months about the need to shift client portfolios from small- and mid-cap stocks to the equities of major corporations with multi-billion dollar capitalizations. Bart Geer, lead manager of the Putnam Equity Income Fund/A (PEYAX) since December 2000, heard those rumblings well over a year ago and began moving the fund’s investments more into a large-cap direction.

Chief among the fund’s stated goals is to provide investors with both income and growth of capital through building a diversified portfolio with a low tolerance for risk. Over the last 10 years the fund has managed to achieve just that, consistently paying dividends to shareholders and increasing the value of each investment while total assets in the fund continued to increase. This is among the reasons the fund was given four-star ratings by both S&P and Morningstar. From a historical perspective, the Putnam fund has slightly outperformed the S&P 500 Composite Index for the one-, three-, five, and 10-year periods, and its style peers for all but the most recent measurements.

According to Geer, any short-term performance lag is due to the fact that the fund may have moved a little too quickly back into a heavy emphasis on larger-cap stocks after having made some moves in the mid-cap direction in late 2000 and early 2001.

Geer has been managing money for 23 years, and while he has an MBA from the Amos Tuck School at Dartmouth, his undergraduate degree was in geology, not a bad academic background for a manager who constantly searches the investment ground for precious gems and metals in the form of value stocks. And while Geer characterizes himself as the one with his “finger on the trigger” and serves as the final decision-maker on picking stocks for the fund, he has two other key players on this team–Jeanne Mockard, who is also portfolio leader for the George Putnam Equity Fund of Boston, and quantitative analyst Mike Abata.

Since you have some assistance in managing this fund, could you explain how the responsibilities break down? I’m the lead manager, so I break ties. I’m responsible for stopping the buck.

Jeanne [Mockard] and I will typically work together on decision-making. It’s more or less by consensus between the two of us. Mike [Abata] is there to give quantitative assistance on the portfolio, which means that he doesn’t actually have a finger on the trigger, but when we’re looking for guidance from Putnam’s quantitative systems, Mike’s the guy.

The way we work together is that we sit down together every two weeks. At that point we look at a custom optimization based on Putnam fundamentals and see what that model is recommending we do. But since we’re not a quantitative product, Jeanne and I–as fundamentalists–take that [optimized model] and massage it to arrive at what we think is the appropriate fundamental response to the quantitative signals we’ve received.

Both S&P and Morningstar list this as a Large-Cap Value fund. Is that how you would define it? Yes, I would, because we use the Russell 1000 Value Index as a benchmark. We use that even though Russell 1000 Value is close to multi cap. It includes a fair amount of mid-cap stocks, but at least during my tenure, it’s mostly in the large-cap space. That doesn’t mean we’re saying we wouldn’t invest in mid-caps.

In fact, before I arrived at Putnam I used to manage mid-cap value money, and at the end of 2000 I was pretty confident that mid caps were more beneficially priced than large caps. So we made a pretty significant tilt in the portfolio to the lower-end capitalizations. Our capitalization was about $10 billion less than the average capitalization for the Russell 1000 Value. But by May 2003 we were getting signals from our models as well as from our analysts that indicated that was no longer the case. So as of last May we moved up our capitalization to approximately that of the Russell and we’ve subsequently moved past it. That turns out to have been premature, which is not unusual in signals of that sort. If you get it within a few quarters, that’s okay.

Is this the only fund that you currently manage? It’s the only style that I manage, but it’s not the only fund. Basically, I’m the lead manager on all of the Russell 1000 Value products at Putnam.

How many funds would that be? It’s not other funds so much as pieces of other funds. What I manage ends up approximately doubling the assets in the fund. The fund is about $2.8 billion in assets, but we’re actually managing $6.1 billion in the style. A lot of the surveys only pick up the A shares, but there are a number of different classes, which is what brings up the total.

This fund is known for having tight risk controls. Can you talk a little bit about what that means? Every portfolio at Putnam gets a risk budget in terms of expected tracking error, which is a quantitative measure of expected risk. We have some very sophisticated systems and we can get a reasonably good approximation of the risks involved in any particular strategy. Like all forecasts, they’re never 100% accurate, but we can get a reasonably good approximation of where our risk is and where we’re spending it.

We typically like to spend our risk more on individual stock selection than we do on big group or sector calls. We don’t want to say, “Oh, yeah, cyclicals are the place to be because of the China trade, so we’re going to put 35% of the fund in cyclicals,” even though cyclicals represent only 5.5% of our index. In all likelihood, unless everything in the market was very tightly correlated, we would very massively blow our risk index doing that.

At the same time, we’re not afraid to buy the groups that we like in appropriate overweights and to sell the groups that we don’t like in appropriate underweights. But we’re not a “swing for the fences” fund on those types of issues. We’ve viewed our competitive advantage as being more on the stock level and then the industry level, and not that much of an advantage on the sector level, unless it rolls up from the bottom.

Tell me a bit about what goes into your stock-picking process, with a couple of examples. We look for stocks that are inexpensive. We’re typically going to look for stocks that have good yield. Where do you get those stocks? To some extent our index describes where you get them. Our index is about a third financials, so financials is a large area for the fund. Not just because of our index, but because historically financials have had a very good risk/reward for the investor, particularly when they’re inexpensively priced. In a market that’s trading at 16.5 times next year’s earnings, you’ve got companies that are trading at 11 times next year’s figures. That makes them pretty inexpensive.