Cleveland native Peter Klein doesn't like to stray far from home, earning both his bachelor's degree and MBA there, and working for a succession of financial services firms in the city. Luckily for him, when Cincinnati's Fifth Third Asset Management, in need of a group specializing in value investing, bought his firm Maxus Investment Group in 2001, they didn't look to move it across the state.
The $345 million Fifth Third Multi-Cap Value Fund, which Klein serves as senior portfolio manager, has posted three- and five-year annualized returns of 23.09% and 8.69%. The fund is a Lipper Leader for its performance.
The reason: After screening stocks to find those Klein calls "statistically cheap," based on price-to-earnings, price-to-book ratios and balance sheet qualities, he and co-portfolio manager James Kirk dig a little deeper.
"We don't necessarily get too concerned about the quarterly progression of earnings," Klein says. "We know that the kind of companies that we're purchasing have some kind of earnings problem." Instead, he and Kirk try to get a sense of whether a company's earnings power is being valued in the market.
"I like to buy pessimism and sell optimism," he says. And this mantra has worked for him – so far. Since taking over the fund at the beginning of 2003, Klein can boast a 23%-plus annualized return, besting by far the Standard & Poor's 500 Index, at 6.6%, and its benchmark, the Russell 3000 Value Index, at just under 18%.
But the fund doesn't just buy pessimism: It wants to find compelling pessimism. "We're not necessarily buying good news today, but good news tomorrow," Klein explains. To that end, he and Kirk, who also serves as chief investment officer of the firm's value strategy in Cleveland, take a look at the boardrooms and bottom line for something – a restructuring, management shakeup or new product – that moves them.
So, while investors fled troubled insurer American International Group after it and its CEO, Hank Greenberg, ran afoul of regulators and New York Attorney General Eliot Spitzer, the Multi-Cap Value dove in. "They did a very thorough job internally," Klein says about the scandal, and believes that an expected $1 billion settlement with state and federal regulators is favorable to the firm. What's more, the regulatory unpleasantness "hasn't damaged their earning power, so we feel very comfortable."
On the whole, Klein and Kirk have only recently begun to warm up to financials, where the fund is underweight its benchmark by about 14 percentage points, 23% to 37%. In addition to AIG, another name they like is the Bank of New York, whose continued overseas securities processing growth and stock buybacks have not been reflected by its inert share price.
Klein also likes industrials, where his fund is overweight. He doesn't expect inflation to be a problem in 2006, and believes that we'll hear "all the bad news about interest rates in the first part of the year, and not the back half of the year, and that's not bad."
He's betting that the general environment, coupled with the scads of cash companies are sitting on, and the lack of capital expenditures over the last few years spell good things in the sector. The fund also finds itself overweight in healthcare, thanks in part to recent changes to Medicare that benefit managed care companies.
Politics haven't only boosted the Multi-Cap Value fund in healthcare; Klein favors alternative energy. "There's going to be more focus on ethanol production," with a pledge to nearly double it by 2012. Because ethanol is made from corn, that spells potentially good news for one of the fund's quirkier picks, John Deere. Deere's product cycle, in terms of farm income and the replacement cycle in farm equipment, could benefit from President Bush's pledge to increase the administration's allocation to alternative energy. "That could be an unusual positive that takes place over the next couple of years," he says.
On the whole, however, after a robust year and strong month, Klein's fund is moving away from the energy sector, where good values are becoming harder and harder to find. "We were somewhat neutral on energy in the fall," he says, but following hurricanes Katrina and Rita, and the spike in oil prices in 2005, "we backed away from some of our energy names."
Not, however, before some, including deep-sea drilling concern Transocean – the fund sold its position in the fall – contributed to the fund's 7.2% return in 2005. And Klein is quick to note that the fund hasn't abandoned energy entirely, holding on to sizeable stakes in oil services companies like Schlumberger, and integrated producers such as Marathon Oil.
On the whole, outside of predicting no "30% to 40% increase in the price of energy," Klein sees relatively smooth sailing in 2006.
"We're looking at a fairly benign year," he says.
