After more than 30 years in the business, portfolio manager Andy Pilara knows who he is and has strong ideas about what works for him and his shareholders. For the RS Value Fund (RSVAX), formerly the RS Contrarian Value Fund, that means doing his homework and finding companies with market capitalizations in the $3 billion to $18 billion range that are selling below their market or intrinsic value and buying them. He’s a realist who is more than willing to accept abnormally high returns, such as the fund has enjoyed recently, when they occur, but who knows that such conditions don’t happen very often.
His approach to the investment market is an understated one and unlike many mutual fund managers, he doesn’t talk much about the upside when the market is booming. “We focus on losing less, not making more,” he likes to say. “That’s more than a trite statement, because we are not going to take the risks to maximize returns. We believe that if you lose less, the law of compounding will take care of you as far as long-term appreciation is concerned.”
In some market environments, like that of the last three or four years, Pilara’s aim of losing less can translate into making more. In 2004 the fund’s performance (29.31%) dramatically outpaced its style peers (18.2%), its benchmark indexes, and the S&P 500, and unlike many funds, it didn’t generate all its returns in the fourth quarter. S&P gives the fund a five-star rating and ranks it first among 296 mid-cap value funds for the one-year period ended December 31, 2004, sixth out of 222 for the three-year period, and 24th of 141 for the five years.
Investors have certainly responded in a big way to the performance figures, leading to a dynamic infusion of new assets over the last two years. The fund had only $57 million at the end of 2002, but since then has grown more than tenfold and finished last year with $625 million in assets. According to S&P data, that puts it in the top 1% of all funds in growth of assets under management (see “The Big Growers” on page 66) over the last two years.
Although the huge capital inflow has given the fund a temporary excess of cash, Pilara has no intention of changing his style or methodology to conform to the expectations of investors who think that it’s possible to reap huge gains year after year. “I will not let shareholder expectations dictate what we do. I’m sure we have some investors who are chasing performance and that with the first sign of performance that is not number one in its category they will no longer own our fund.”
The last thing he seems to want is shareholders anticipating unrealistic returns. “Reasonable expectations in a normal market environment would be 10% to 12%. Sometimes we’ll do better and sometimes worse, but over the course of a five- to 10-year period, that’s the way you create shareholder value. We’re trying to optimize performance rather than shoot the lights out. Our performance in the last three years didn’t come because we hit a lot of home runs, it came because we didn’t strike out a lot. I think that baseball analogy is apt, because when you take those big risks, like what happened in technology, it takes you a long time to come back. The laws of compounding work really well when you don’t blow a hole in your portfolio.”
At a time when many observers are predicting single-digit returns for the major indexes, when Pilara speaks to shareholders he talks about annualized rates of return for the next five years in that 10% to 12% range. “I’m not saying that’s right or wrong, because I’m not a stock market pundit, I’m just a portfolio manager who tries to buy good companies at the right price for his shareholders.”
Pilara admits that the above statement reeks of motherhood and apple pie, but what’s wrong with that? It’s obviously an approach that has stood Pilara and the RS Value Fund in good stead and seems likely to continue to do so for years to come.
I noticed that the official name of the fund is no longer the RS “Contrarian” Value Fund. By dropping “contrarian” from the title, were you indicating that you’re now going to go along with everyone else? Hopefully, we’re still taking the road less traveled. The reason we dropped contrarian was not because we changed our investment philosophy or changed the way we look at the world. We dropped it because this was a fund that historically, before I took over, had shorted stocks. It’s a fund that had used options, and I wanted to send the signal that this is a plain vanilla value fund without the risky options or shorting associated with the old contrarian fund.
The literature on the fund lists, besides you, two co-managers. What role does each of you play? I set the portfolio strategy and portfolio policy and then we set the major investment sectors. Healthcare is under Joe Wolf’s watch; the financials under Dave Kelley; the resources, industrials, and staples are under my watch. Then Joe and Dave combined do the consumer discretionary and the more technology-oriented companies. That’s how we cover the universe, but I’m the portfolio manager, so at all times, because we have a small shop, I know which stocks the co-portfolio managers are looking at or going to start looking at.
How would you describe the investment philosophy behind this fund? The philosophy is one of cash flow and rates of return. We’re value investors, but we’re not the classic low P/E and low price-to-book value managers. We believe that value is derived from buying companies below their business or intrinsic value. The best way to do that is to analyze the capital deployment of a company. I guess we would be considered business analysts as well as stock analysts because we’re looking for the same things that companies look for in making acquisitions. That is, structural changes in the business [environment], the dynamics of a particular business, and the business model.
S&P calls this a mid-cap value fund and gives it five stars. Morningstar says it’s a mid-cap blend with a three-star rating. How do you define the fund and what benchmark do you use to gauge performance? I define it as a mid-cap value fund. Sometimes the boxes that we are placed in are somewhat arbitrary, although I know there are objective standards used in making those classifications. As an example, [take a] company that might not have earnings but has a lot of real estate and we’re buying it for less than the real estate is worth. Because it has no earnings, it would not be considered appropriate in a value fund.