| Thomas Galvin |
Market-watchers spent much of 2005 beating the drum for the return of growth investing. Thomas Galvin couldn’t agree with them more. The slowdown in corporate profits, from upwards of 30% three years ago to an expected 5-10% this year, “may lead to a style shift,” the manager of the Excelsior Large-Cap Growth Fund says, and he appeals to history.
Galvin argues that the 2000-2005 period matches up nicely with the 1980-1985 and 1990-1995 periods. Each decade began with a recession, followed by Federal Reserve rate cuts-led growth, followed, in turn, by slowing economic growth as the Fed got skittish about inflation. In short, in the current period, Galvin argues that the economy is “moderating; it’s not recession-bond by any means.” But it is slowing, and, coupled with “generally compressing” price-to-earnings ratios, that makes for “a stock market that is much more narrow and selective.”
“Back in 2003 or 2004, when the whole world was growing at 20% to 30%, we weren’t so special,” Galvin concedes. “Now, we’re considerably special, because our companies tend to grow at two-to-three-times the clip of the rest of the market.”
Since joining Excelsior parent U.S. Trust as head of its growth equity division in February 2003, Galvin has overseen a major turnaround in fund performance, not only the result of the turnaround in growth investing. Long a laggard in the large-cap growth category – the $451 million fund trailed both its benchmark, the Russell 1000 Growth Index, and its Morningstar Inc. category average throughout the 2000-2003 period; over the past five years, it’s been bested by 85% of large-cap growth funds – the Excelsior fund has exceeded both its benchmark and its category average in every year since Galvin took over. In 2004 only 7% of large-cap growth funds beat the Excelsior fund, and last year only 12% did so, according to Morningstar. This year, it’s off somewhat more slowly, but is still ahead of two-thirds of its category rivals. Morningstar, which rates the fund only two stars, is kinder to the period of Galvin’s tenure, giving it a three-year ranking of four stars.
Galvin also heads U.S. Trust’s large-cap growth separately managed accounts program, and ensures his holdings have what it takes to grow by strictly limiting his universe to about 140 stocks. Each must have earnings growth in excess of 12%, and a return on equity of better than 15%. That leads to a highly-concentrated portfolio of about 30 stocks – currently 33 – heavily invested in the biggest companies; the fund has an average market-cap of almost $40 billion, with almost 45% of the fund in mega-cap stocks. That level of concentration is crucial, Galvin says, because the current rate cycle “suggests that rising tides are not going to lift all boats.” As opportunities in the growth sector increase, Galvin expects his fund’s turnover rate to increase to between 20% and 30% in 2006, from about 17% last year.
The Excelsior fund’s stock-picking methodology means that its manager focuses on names, rather than sectors, but that doesn’t mean Galvin doesn’t have any sector favorites. “We talk about mind share,” Galvin says, “but it’s really about wallet share: the percentage of your shopping cart.” And healthcare and leisure entertainment are winning an increasing piece of it. “Those are pretty significant trends,” Galvin says.
Indeed, Galvin sees in healthcare stripped of large pharmaceuticals this decade’s answer to the tech sector of the late 1990s, and he has devoted about one-third of his investors’ money to it. He also likes tech, which is overweight at about a quarter of the portfolio, and the consumer side, which makes up almost 20% of the fund. Galvin says those areas are his big bets, though he’s not averse to a shakeup within: last year, the fund sold pharmaceuticals giant Eli Lilly and bought biotech Genentech, and eliminated its position in retailer Kohls in favor of Coach.
Of Genentech and Coach, Galvin says he sees “better, faster, more consistent growth opportunities.” But neither matches his love for Apple Computer, whose praises he sings and whose position in the fund he increases, to about 3.3% of the portfolio. “This is a consumer marketing machine,” he argues. “They have created a market, the MP3 market, which didn’t exist five years ago, and they continue to dominate despite having a lot of competition.”
The iPod’s success – and Galvin sees more successful iPod products coming to market in 2006 – has created a “halo effect,” bringing people into Apple’s stores for accessories and “creating renewed consumer interest in their PCs.” That, in turn, “will probably lead to an even stronger profit picture over the next year or two.” Not that it hasn’t already done the fund good: Apple has more than tripled in price since Galvin first bought it.
Outside of his favorite sectors, Galvin likes hot financials player Chicago Mercantile Exchange Holdings, which is at the center of an explosion of interest in futures and other derivatives products. “You’ve got a secular force which is about risk management,” Galvin says, an area in which the CME continues to innovate, most recently with its introduction of snowfall futures. “It’s just a cash machine,” according to Galvin, who predicts “earnings growth north of 20%" for the next several years.
The fund also has about 15% of its portfolio invested in foreign stocks, but don’t look to Galvin for a regional or country bet. “We’re not really interested in buying those economies as much as buying companies that are really taking advantage of their cost structure or innovations to get superior growth,” he says. To that end, the fund owns Israeli generics manufacturer Teva Pharmaceutical Industries, Mexican wireless company America Móvil and Indian information technology outsourcing firm Infosys.
Galvin’s bet on consumer-heavy sectors is no accident, as he thinks much of the negativity about the economy is misplaced, even if corporate earnings are set to slow. “It’s about jobs, and jobs breed confidence,” and, with historically low unemployment rates and unemployment claims, Galvin says there are a lot of them out there. Inflation, in spite of the Fed’s worries (or as a result of its recently hawkish talk), is also low, leading to stronger purchasing power. And while there will be “pockets of slowdown” – Galvin points to the homebuilder industry – companies like Apple are set to vie for a larger share of the consumer’s growing wallet.