Heading into the next quarter-century of Investment Advisor, we wondered if there were any diversified equities funds that have been managed for 25 years or more by the same manager. While there is an elite group of portfolio managers with this kind of longevity, those with consistently good performance are extremely rare. One member of this exclusive club is James Stratton, chairman and CEO of Stratton Management Company in Plymouth Meeting, Pennsylvania. “Stratton Management manages around $2.3 billion all told, and mutual funds represent about $700 million of that; the rest are private accounts and institutional business,” says Stratton, who founded the $167 million, no-load Stratton Growth Fund (STRGX) in 1972 and has managed it ever since. The fund boasts an average annual total return of 13.10% for the 25 years ended September 30, 2005.
The fund has earned an overall four-star ranking from Standard & Poor’s, with a 5-year average annual return of 13.07% versus 0.64% for its peers in the S&P 500 Index, and a three-year average annual return of 24.37% versus 12.09% for the S&P 500 Index.
What is your investment process? We are basically a value manager across the board–that’s our style. We screen stocks; we have a complicated, quantitative computer formula; and we use value measures. About 70% of the formula is value measures–things like price/earnings, price/cash flow–interpreting whether stocks are cheap in general. The other 30% relates to earnings growth and price momentum to see whether the stocks are doing anything from an earnings and a price standpoint, because we just don’t want to own a cheap stock that remains cheap, we want to own a cheap stock that looks like it can appreciate in value. We do that screen, and we rank them–this is something we do a little differently than others–by industry or major category sectors: all the energy stocks together, all the financials together. Then we rank them in order of their relative attraction, so we will always be looking at how they compare with other stocks in their sector. Then we start the actual stock selection process, looking at those that appear the most attractive and seeing if they qualify on basic fundamentals. We will not put more than 20% into a single sector.
I noticed in your top 10 holdings that energy was prominent. Energy right now [Dec. 9] is 18.5%– it’s our leading sector. The second we call capital goods, at 12% to 13%, which are companies that would benefit from business spending, like Caterpillar Tractor (CAT) or Ingersoll-Rand (IR), or a more controversial one, Tyco (TYC)–the type of companies that build things for industry. Home builders are our third largest sector, where we have 11.5%, then insurance at 9%, and transportation at 9%. We’re pretty well diversified among the sectors, but we are prepared to concentrate heavily in a sector we really like, and also avoid sectors that we don’t like. Right now we don’t own anything in the consumer staples area, and very little in the utility area. We have been of the belief that the economy is strong, revenues are strong, earnings are very strong, and we should be in the most rapidly growing areas of earnings growth during this expansion of our economy. It has worked out for us.
Your strategy has worked out for a long time, and looks very consistent. How do you achieve that? We have been doing the same thing–we have tweaked how we go about doing things–but we have not wobbled or ventured far from the path I described. Over the years, that’s been very effective for us, with one two-year exception: 1998 and ’99, when the value style was clearly out of favor, [during] the technology bubble. We were totally left behind in those two years. They were probably the worst years in my career. It was so persistent and it was so easy for people to make money in other areas that they almost felt like you were not necessary. For two years we seriously underperformed; when the crash came in 2000 that was wonderful for us because it put us back in the driver’s seat in terms of what we were doing, and we’ve had very good performance for the last five years. The very nature of our style is such that if you ever get another bubble we’re unlikely to participate; fortunately those things happen only about every 30 years.
Were ’98 and ’99 worse than 1973 to ’75? In one way they were, because in the early ’70s, the whole market went down, nobody made money, and while it was very painful because you were losing money for the fund or for clients, everybody else was losing money. In ’98 and ’99, we weren’t losing money, we were actually just standing still, but everybody else was making a lot of money in Internet and biotech stocks. [Shareholders were] saying, “What’s wrong with you? It’s so easy to make money and you’re not making it!” So psychologically, yes, ’98 and ’99 were worse than ’72-’73. Neither are periods that I’d like to remember.