Nov. 15, 2004 — When an observer characterizes the Berwyn Income Fund (BERIX) as a bond fund that also owns stocks, portfolio manager Edward Killen agrees.
Common stocks, which must pay dividends, can account for up to 30% of the assets in the fund. It gets fleshed out with fixed-income securities, convertible and preferred equities, and cash. Over the years, the portfolio has emphasized investment-grade and high-yield corporate bonds, Killen says.
“It’s a counterbalance, really, to an aggressive equity investment,” Killen says of the $195-million fund, which he’s run for more than ten years.
Berwyn Income, which was launched in 1987, was originally intended to compliment the Berwyn Cornerstone Fund (BERCX) and the Berwyn Fund (BERWX), which concentrate on stocks.
At the end of the third quarter this year, about 64% of the fund’s holdings were in corporate bonds, including junk bonds. (It can also buy U.S. Treasurys and government agency bonds.) Some 24% was invested in common stocks. Convertible securities and preferred stocks accounted for approximately 4%. The fund’s cash stake was 8%.
The fund’s investment blend resulted in a return of 5.7% this year through October. By comparison, its asset allocation-hybrid U.S. income fund peers were up 2.9% during that span. Berwyn Income gained 10%, and 9.3%, respectively, on average, for the five and ten years ended last month, while similar funds rose 3.9% and 6.7%.
In choosing investments, Killen and the fund’s analysts consider the qualities of individual companies as well as macroeconomic factors.
When picking common stocks, the team looks for shares priced low compared to a company’s earnings. Beyond that, they want to see businesses with little debt; solid balance sheets, margins and cash flow; and high returns on capital or assets.
The fund can buy companies of any size. Analyst George Cipolloni III, who joined Berwyn Income two years ago, says its current roster of stocks features giants like drug maker GlaxoSmithKline plc ADR (GSK), and Hawkins Inc (HWKN), a small-cap specialty chemicals producer.
Around 25 common stocks make their way into the portfolio. That number facilitates research and enables winners to make significant contributions to the fund’s performance, Killen says.
About a month ago, the fund began buying SpectraLink Corp (SLNK), which makes wireless telephone systems for businesses. The stock had gotten beaten down after the company posted disappointing quarterly earnings earlier in the year, Cipolloni said. The company remained attractive, however, because it has historically generated “very significant” returns on capital, he said. In addition, Spectralink has no debt, churns out cash, and sports a dividend yield of more than 3.5%, he says.
More recently, the fund has invested in shares of MGE Energy (MGEE), a power generator. Killen sees the utility, which he says uses coal to produce about half the energy it sends out, benefitting from high oil and natural gas prices, which make coal more attractive.
The fund’s top stock currently is food processor ConAgra Foods (CAG). Cipolloni says he likes the company because it has a “very diversified” product line, and its brands typically rank No. 2 in their categories. Also, by getting out of commodities businesses in the last few years, ConAgra has been able to fatten its margins “by a substantial amount,” he says.
Killen, who will sell a stock if its valuation gets stretched, says he eliminated another food company, Heinz (H.J.) (HNZ), from the portfolio earlier this year, because its shares had run up.
Overall, the rate at which the fund turned over its holdings clocked in at 54% last year, compared to 50.1% for its peers. Normally, though, his turnover rate would be about 25%, Killen says. Sales of several stocks that had appreciated, like printer and publisher Donnelley(R.R.)& Sons (RRD), help push turnover up, Killen says.
On top of that, Killen says it increased because he was repositioning his bond portfolio to lower its duration (a measurement of sensitivity to interest rates) in anticipation of a tightening of monetary policy by the Federal Reserve.
Killen points out that, as a rule, the fund is not volatile because his value orientation steers him away from hot investments that can cool rapidly. Cipolloni notes, too, that the fund’s mandate to hold only dividend-paying common stocks leads it to emphasize investments in conservative businesses and industries, like utilities and banks.
The fund’s stability is illustrated by its beta, which measures sensitivity to changes in the market. Berwyn Income’s reading is 0.13, versus its peers’ 0.25. By comparison, the S&P 500 index has a beta of 1.00.
“We need to keep in mind that our clients need income, and we want to try” to provide it “with the lowest volatility possible,” Cipolloni says.
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