A Quantitative Blend of Bonds and Fundamentals
Harris Insight Balanced Fund
C. Thomas Johnson
Author: Dave Jennings
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|The right mix of stocks and bonds at the right time has kept the Harris Insight Balanced Fund, managed by investment veteran C. Thomas Johnson, outperforming the S&P 500 for the past five years ending March 31, 2003. Johnson told Ticker why he thinks the equity side, particularly growth issues, will outperform value.
||Harris Insight Balanced Fund|
I think it can be used both ways. We haven't had any capital gains distributed over the last several years, obviously, because of the weak overall equity market. Going forward, we won’t have problems with capital gains for sometime even though we are active managers. Because we are active, we don't have a lot of cost basis that goes back three, four or five years. We are tax aware, but we have not had to manage gains in the last few years because of what the stock market has done.
Q: The majority of the holdings are primarily large cap. Not only that, it is fairly well dispersed across industry sectors. Is that part of the basic approach?
Let me take a second and tell you how we approach the equity side of things. We have three distinct equity styles reflected in the portfolio. When you look at it on an aggregate basis, you don't have an opportunity to see that. The core of our equity holdings are what we would classify as large-cap value oriented securities. In addition, we have a portion of the fund allocated to large-cap growth. We also have a portion invested in small-cap value securities. When I say large-cap growth and value, we're very benchmark sensitive, to the Russell 1000 Value and the Russell 1000 Growth indexes. Our small-cap value issues focus on the Russell 2000 Value index. We definitely believe that in the long run, value will be the winning style. History tells you that as long as growth and value statistics have been kept, value has outperformed growth with less risk. Thus, we believe it is appropriate to have a value bias. In order to give our shareholders a balanced or diversified portfolio, we believe they should also have a small-cap exposure. Thus we have capitalization coverage as well as style coverage. What we try to do is emphasize the appropriate style at the right time. As a result, over the last couple of years, we have had a heavy emphasis on the value side of things, especially small-cap value, and have only recently begun to increase the growth holdings in the portfolio. When you look at the sector exposures, you're seeing all three of these styles blended together in those numbers.
Q: Since you are using the benchmark indexes for the initial screen, what else is there to the selection process?
For each of the particular equity asset classes, we are what you would call a quantitatively driven asset fund.
Q: The way I understand quantitative analysis, one plugs in selected criteria into a database in order to narrow down the list of appropriate names. How does your fund treat this process?
We are a variant of that to some degree. We'll run through it for one of the asset classes and then you can extrapolate it to the other two. Since large-cap value is the biggest portion of the equity portfolio, what we will do is look at the universe of candidates out there. If it's in the large-cap universe, we might start with the Russell 1000, so the screens are going to knock out 100 plus names that don't have the quality or liquidity that we're comfortable with. Every stock in the universe is evaluated on the basis of about nine different variables that we’ve identified as having value in terms of predicting future stock prices. We have a quantitative group that has gone back and done that type of factor research.
Q: Does the fund use proprietary search software?
Yes. And as result of those nine different variables, every stock in this universe of 800 to 900 names is evaluated and then ranked from most to least attractive, based on those factors or variables. Once we've done that, we will scale an alpha to this universe from most to least attractive. Then we use a portfolio optimizer.
Q: What does it entail?
The optimizer takes that data and generates a model portfolio relative to the benchmarks I mentioned earlier. In each of these three sub portfolios, we will then come up with a list of buys and sells that best reflect the current variables that we think are most important. Those suggested buys and sells are then reviewed with our research analysts to insure that the data going into our quantitative process is accurate.
Q: Isn't that a problem inherent to quantitative screening?
Right. That is why we think it is important to have a fundamental overlay. From the research analysts' participation, we will then ultimately make the purchase and sale decisions that we think are appropriate.
Q: What you're telling me is that, based on a look at the five-year chart for the fund, this screening process must work pretty well for you.
The long-term record has been favorable because we have shifted the emphases between the various asset classes in the fund. Back in early 2000 we didn't hold much in the way of growth at all because we thought growth stocks were egregiously overvalued. We had a big emphasis on value and a bigger emphasis on small value. As you know, small value has been a homerun over the last several years. As things were unfolding last year we began to reduce the value exposure and started to build in a little more growth. But also going back over the last several years, we felt that not only did we think growth was overvalued, we thought stocks were overvalued, so the percentage of the fund in equities was consciously reduced and that money was invested on the fixed-income side.
Q: That is the advantage of a balanced portfolio. You can always go to bonds.
We have the option of reducing the equity exposure and holding a few more bonds if it's appropriate. Now we're on the other side of that. We are now increasing the equity allotment. We had a below average allocated to equities for balanced funds at the peak of the market. We now want the equity exposure to be above average because we think the likelihood going forward is that stocks will do better than bonds and that will help investors in this fund.
Q: What is the depth of your research on the equity side at Harris Insight?
We have two levels of research, one of which is quantitative. We have several individuals with advanced degrees that are doing the factor research to try and come up with better variables. We've been doing this type of research since the early 1980s. I'd like to say we're one of the pioneers at applying some of these ideas. On the fundamental side, there are eight equity research analysts. Each is assigned to follow a broad segment of the equity market to ensure coverage of the universe of stocks we have an interest in.
Q: Obviously that results in turnover. How does it rank relative to peers from the equity side?
In the aggregate, especially over the last several years, our turnover has probably been a little higher than the average. We've been able to have it be higher than average without it being a source of tax-related problems for reasons mentioned earlier. Because of the volatility of the market, the relative attractiveness of names has bounced around quite a bit, so that has led to more turnover than might be normal on a long-term basis.
Q: Compared to the fund's five-year performance with benchmark indexes, has trading made sense?
Yes, and we hope that the next several years will be a whole lot easer for everybody to make a little bit of money. It will make us all happier.
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