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Portfolio > Mutual Funds

Fund in Focus: AXP Equity Select Fund

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March 3, 2005 — As a growth manager, San Diego-based Duncan Evered admits he invests less aggressively than others might. That’s because he sees investors in AXP Equity Select Fund/A (INVPX) as people who are saving for retirement and need to preserve and build capital. While aggressive enough to invest in a growth fund, these clients “certainly don’t want to lose principal,” he said.

Like the climate of his host city, Evered’s fund doesn’t run to extremes. It tends to lag its peers in both gains and losses. For instance, for the one-year period ended Jan. 31, 2005, the fund rose 2.5%, versus a gain of 6.7% for its mid-cap growth peers. Over three years, it registered an annualized gain of 4.1%, beating its peers, which returned 3.6%. The results were achieved with less volatility.

Evered’s style is less than “laid back” when it comes to researching and monitoring his investments. As sole manager of the fund, he draws on the expertise of six industry analysts who contribute to other AXP growth funds, a quantitative analyst, and a trader, all based in San Diego. He says his “hands-on, research-intensive process” seeks to identify firms with market capitalizations between $1 to $8 billion that can grow earnings at 15% a year at a sustained rate, and that have “the wherewithal to become significant entities.”

Evered, who has managed the fund since February 2000, just prior to the stock market’s peak, describes his approach as bottom-up and research driven, the most important aspects of which are interviewing company management, reviewing 10K and 10Q reports, and analyzing competitive landscapes. He attends trade shows, visits companies, and talks to their customers and vendors to obtain information.

Evered seeks stocks of companies with sustainable earnings growth over two to three years. He looks for durability and defensibility in a firm’s relationships with its customers, and for recurring, consistent results on the income statement and balance sheet. The income statement should indicate the company’s “special, unique, and differentiated” status — i.e. evidence that a particular company is the one “you’d rather not be competing against” if you were in that industry.

Evered cites Coach Inc (COH), Chico`s FAS (CHS), and Starbucks Corp (SBUX) as examples such companies in the consumer discretionary area; and Paychex Inc (PAYX) and Fiserv Inc (FISV) in the business services sector. The manager is particularly interested in the latter “applied technology” companies for the way they have adopted information technology to business purposes. Paychex represented 2.2% of fund assets as of December 31.

Another star performer in the fund is Whole Foods Market (WFMI) — the top holding in the portfolio at 3.7% of assets. It’s the “largest company in the fastest growing segment of the grocery story industry,” Evered said. He adds that while one might not think of this industry as a place to invest for growth funds, this company is a good bet. “They operate about 160 stores and have 30-plus stores in the pipeline,” he noted. The company is “responsive to consumer tastes and has superior merchandising skills.”

Holding 60 to 80 positions at any given time, AXP Equity Select has a bias toward concentration. After Whole Foods, top holdings as of December 31 were Fastenal Co (FAST), an industrial and construction supply distributor, 3.2%; Starbucks, 3.0%; Biogen Idec (BIIB), a biopharmaceutical company focused on treatments for cancer and autoimmune diseases, 2.9%; and Diagnostic Products (DP), a manufacturer of immunodiagnostic systems and kits, 2.9%.

Evered likes to buy into a company when its capitalization is in the “low billions of dollars,” and to sell it in the high teens or low twenties. However, if a company exceeds the fund’s market-cap range, Evered is not obligated to sell it, as is the case with Starbucks. “But anything over $10 billion gets additional scrutiny,” he said. The fund’s turnover is generally low, making tax efficiency a priority.

Evered’s sell criteria may include any negative company-specific changes, such as in investor expectations, or changes in company management or behavior, like a failure to attend a regular investment conference. Such developments could signal that things might not be well with that company, or that its advantages are being undermined. Evered keeps an eye out for such developments, as well as for “chronic underperformers.”

The manager aims for a diversified fund where no single sector dominates. “We’re not driven by a benchmark, but we want to be sensitive to sector weights relative to benchmarks,” he said. As of Dec. 31, 2004, the fund’s top sectors were healthcare, 22.3% of assets; business services, 21.5%; consumer services, 15.9%; energy, 9.2%; and computer hardware, 9.1%. Two areas that tend to be underweight are utilities and materials. “By definition, there tends not to be much in those areas” among mid-cap companies, he noted.

Reflecting the fund’s recent underperformance relative to its peers, Standard & Poor’s lowered its ranking to 3 Stars from 4 Stars in January 2005. Still, the fund’s 10-year ranking remains at 4 Stars.

Evered’s cautious growth strategy hurt the fund in 2003 and somewhat in 2004. Indeed, the portfolio lagged its peers in both those years. In 2003, he didn’t own the kinds of technology firms that he says got a “significant bounce.” In 2004, when lodging and gaming companies boosted consumer discretionary, the fund held retailers and media companies. But In more challenging periods for the market, such as 2000 and 2002, the fund has been more resilient than its peers.

For the market overall in 2005, Evered expects a “modest” positive return. “Interest rates are going up, corporate earnings are slowing, credit spreads are going to widen,” he predicted. “As corporate earnings slow, those companies that can sustainably deliver earnings growth are going to be rewarded for that.”

Evered speculated that small-cap outperformance has “probably run its course relative to large-cap companies,” echoing the sentiment of a number of experts and strategists. “Value funds probably have run their course too, and growth funds are likely to do better,” he said. While he admits that nobody knows what the market will do, Evered expects the momentum in mutual funds to “shift from small-cap value to large-cap growth.” He believes that mid caps will also benefit from the seachange.

On Feb. 1, 2005, parent company American Express (AXP) announced it would spin off its personal finance unit, American Express Financial Advisors, investment advisor for the Equity Select Fund, in the third quarter. Looking ahead, Evered expects the corporate spin-off to have little effect on his fund’s day-to-day operations. He also sees the additional “autonomy and accountability” as a positive development that will allow the division to focus just on asset management.

Contact Bob Keane with questions or comments at:[email protected].


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