Interview: Barry Ogden of Waddell & Reed Advisors Tax-Managed Equity Fund

Quick Take: When Barry Ogden took over the Waddell & Reed Advisors Tax-Managed Equity Fund/A (WTEAX) in January 2002, he unloaded stocks which incurred significant losses following the implosion of the tech bubble. By October of that year, the fund had lost 39.4% of its value, in line with its large-cap growth peers, which plunged 53.4% on average. The S&P 500, the fund’s benchmark, shed 43.7% over the same period.

However, the $67.2-million fund, now ranked 5 Stars by Standard & Poor’s, has since recovered. For the three years ended July 29, 2005, it registered an annualized return of 13.0%, versus 10.6% for its peers and 12.6% for the S&P 500. For the one-year period, the fund gained 19.0%, versus figures of 14.1% and 14.0%, respectively, for its peers and the S&P 500.

The fund’s standard deviation, a measure of volatility, is 10.97%, well below its peers’ 13.95% average. Its expense ratio of 1.40% is comparable to the peer average of 1.44%.

The Full Interview:

S&P: Can you describe your investment philosophy?

OGDEN: It’s a blended, bottom-up/top-down approach. We have a group of about 20-25 analysts that help the fund managers on a daily basis. The managers get together once a week to talk about ideas on a macro or worldwide basis. We do individual research, go see companies, and go to conferences. But at the end of the day, I’m more focused on identifying stocks that are going to outperform the market over the next six to 12 months at a minimum.

S&P: What is your investment strategy?

OGDEN: We have no hard and fast buy/sell criteria; there is no list I go through on a daily basis. Our method involves a variety of factors — for example, is this company growing its top-line? As a growth company, it needs a strong balance sheet and good operating and free cash flow to be able to finance that growth.

Most of my companies’ top lines are growing in excess of 8%; they’ve got margin expansion, operating income is growing at 15%-20%, and earnings per share is climbing 20%-25% — thus, they’re getting leverage throughout the income statement.

S&P: How do you define “growth”?

OGDEN: I’m not necessarily looking at trailing price-to-earnings ratios, I’m trying to look forward. What is the true earnings power of this company over the next two to three years? How much higher is that than current Wall Street consensus estimates?

S&P: Do you only buy large-cap stocks?

OGDEN: Our mandate says it’s large-cap growth. Right now that threshold is at about $12 billion to $13 billion, so I must keep 75% of my assets in companies with a market cap greater than that. I can have 25% or so in both small- and mid-cap names.

S&P: How do you manage risk?

OGDEN: Largely through the number of holdings we keep. Typically, the fund comprises about 75 to 85 names — more than 100 is too many to monitor. With less than 50, I think a fund can become too concentrated.

S&P: Can you explain the “tax managed” elements of the fund?

OGDEN: It’s a long-term, buy-and-hold strategy. My turnover in the last two-and-a-half years has been well under 100%. When I took over the fund, we restructured the portfolio and sold a lot of names that incurred pretty significant losses. We built up a capital loss carry-forward that has protected our shareholders quite nicely over the last three years, and should protect them throughout the rest of this year.

S&P: How are you making money off these stocks and not having to pay taxes?

OGDEN: In the best-case scenario, I make a lot of money for my shareholders through market appreciation and capital appreciation. But at some point, somebody is going to have to pay taxes when we sell. My shareholders don’t want me to hold onto something that goes down significantly in value to avoid paying capital gains.