ClearBridge Value: Making It A Top Mutual Fund Again

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How do you follow a legend?

That's been one of the challenges for Sam Peters, who has been lead manager of $2.7 billion ClearBridge Value since taking the baton from Bill Miller about two years ago.

Miller -- who still runs $2.1 billion Legg Mason Opportunity -- ran Value from its April 16, 1982 inception until April 30, 2012. He famously beat the broad stock market as measured by the S&P 500 for 15 years in a row -- from 1991 to 2005.

Miller's winning streak came to an end. Peters joined as co-manager in late 2010 and took the lead in April 2012.

Peters has made progress in returning Value to the apex among top mutual funds . The fund beat 24% of its large-cap blend peers in 2011, 46% in 2013 and is ahead of 83% this year through July 31, says Morningstar Inc.

The fund changed its brand name from Legg Mason on March 1.

Peters, 45, discussed his investment approach from his office overlooking Baltimore Inner Harbor.

IBD: Is the crux of your strategy the pursuit of mispriced stocks?

Peters: We look at traditional growth stocks and traditional value stocks. We go up and down the quality spectrum. We try to come up with a reasonable range of business values (for a stock) under future scenarios. I'm a valuation manager. But the real expertise is looking at stocks and free cash flow analysis, then over time figuring out what powers a stock's return and finding those with a price-to-value gap.

IBD: Many people say no one can do that consistently for long periods.

Peters: Any time you're an active manager, you have to take a humble approach. The market's tough to beat. Once an analyst comes to me with a stock whose valuation is 60 or 70 or 80 cents to the dollar, I ask what is the market getting wrong? I look for things that strengthen or weaken the investment case. I look for reasons why the market's expectations are wrong. Most of the time, it is not wrong. We look at hundreds of stocks to find a few where the market is wrong.

IBD: How come you don't end up with a lot of broken stocks?

Peters: I don't want Frankenstein. I want the most diversification I can get in a concentrated portfolio -- I own only 40 to 50 names -- but I don't want to pay for it. We've got to be disciplined. It takes time for (mispriced stocks') price and value to converge. That's why our average holding period is three-plus years.

IBD: How does your approach differ from Bill Miller's?

Peters: I became co-manager in November 2010. He was a good coach. I started changing some things. He encouraged me. I like to cast my net wider, for example. We were very underweight in health care when I came on board. And I have a health care stocks background. So we went from 4% underweight (vs. the S&P 500) to about 6% overweight. I cut some financials and housing stock to do that. I also sold some tech names.

We're overweight energy. We weren't when I came on board. We're very overweight financials now and we're overweight tech. Health care peaked at 6% overweight earlier this year.

IBD: For people who may not know, what is your health care background?

Peters: I managed the global health care team at Fidelity and managed Fidelity Select Health Care and Select Medical Equipment funds from January 2004 to April 2005.

IBD: How else does your approach differ from Miller's?

Peters: Take breadth. Let's say there are 10 great price gap stocks. If two are home runs you can hit out of the park, Bill will concentrate on those. I'll take more names, even if there's less upside. I'll add four or five nice valuation bets and diversify the fund more.

IBD: Is the purpose of added diversification to cut volatility?

Peters: It's not necessarily to make the fund less volatile. But the result is that it is less volatile over time.

IBD: What's your biggest bet?

Peters: I'll answer that this way. My biggest overweight is a bet on higher interest rates. That's moved against me year-to-date, but I'm still ahead of the market.

IBD: Do you still pick Miller's brain?

Peters: He's been my biggest mentor. Always will be. We are very close friends. I have the utmost respect for him.

He was relieved when I charted my own course. That contrarian streak in buying negative price momentum and being differentiated, that got reinforced by and I learned a lot from Bill. I learned about being intellectually diverse, reading widely, talking with people, not being dogmatic, all from Bill. Yet it allowed me to be different from Bill.

We talk investing, but we rarely talk individual names.

Bill is a huge contrarian (too). We share that common DNA, and he pushed me to really think for myself and look at the facts, which is essential if you are going to have a contrarian approach. Be contrary to opinions and not facts.

IBD: How much skin do you have in the game?

Peters: I'm one of the larger shareholders in the fund, which is how it should be. It's the largest chunk of my net worth. My SEC disclosure has me over the $1 million mark. When I get bonuses, I add to the fund. I am the largest individual shareholder in the fund, though some institutional shareholders have more.

IBD: Your June disclosure shows your stake inApple ( AAPL ) jumped to 1.3 million shares from 205,000 as of April 30. Apple had a 7-for-1 split, so did you also trim?

Peters: Yes, Apple had a split, and I've actually been trimming.

I typically buy when a negative narrative goes too far. I get excited if the hurdle goes from 4 feet high to an inch high. That was the case with Apple at 400. At 650 it's a tougher case. (Post-split Apple is trading around 95.)

People are excited about a 6-inch screen (on the iPhone) and a watch that are supposedly coming.

But Apple is discounting flattish margins. It is discounting some growth. And it's a higher hurdle to jump over. It's not massively overvalued. But it's less interesting than it was.

IBD: Celgene ( CELG ) is another recent split, right?

Peters: It is. This is a classic for us. We got involved before the big biotech run, when it was a value stock. When I joined the fund, health care was in the dumps.

I love positive price momentum. I just don't want to pay for it. We trimmed before biotech got hit in March. Then when Celgene got sold (by the market) in Q2 we added back when expectations got reset. I think Celgene will be a long-term winner. And we think Celgene will prevail on its Revlimid patents (in its court fight against Natco, which is developing a generic rival for Revlimid).

IBD: Is fracking the bedrock of yourHalliburton ( HAL ) play?

Peters: They put straws a mile down into the ground, go out 5,000 feet horizontally, then blow up rock underground to drive more oil up. The more complex those wells are, the better the economics for Halliburton.

What we noticed about the shale revolution is that rig productivity is doubling every three years, which is amazing. Halliburton is capturing a lot of those efficiencies.

IBD: Why did you trimBroadcom ( BRCM ) between April and June?

Peters: This was classic for us. Broadcom was doing some bad things, throwing huge amounts of money into chasingQualcomm's ( QCOM ) monopoly in baseband chips. They made no headway. They diluted their own fundamentals on an uneconomical bet.

They ended up with the lowest valuation of all large-cap semiconductor stocks. We bought when everyone told us we shouldn't. It was in the high 20s. (Now it's trading in the high 30s.) It was so bad, it was good. We thought they would get pressure from employees, shareholders, their own board to fix things. We felt if they made changes for the better, the stock would go up a lot.

And last quarter, lo and behold they said 'Uncle.' They stopped chasing Qualcomm's monopoly in baseband. They said they'd give back more to shareholders. Profit margins would go up. So you'll see positive earnings revisions.

We still think the business value is higher, somewhere in the 40s. Now it has positive momentum. We have a big position. So you'll see us trim a little.

IBD: Calpine (CPN) earnings-per-share growth has accelerated for three quarters. What's your thesis?

Peters: We began buying early this year around 19. Late first quarter, early second quarter. They're taking a 12% free cash flow yield, which is extremely high, and buying back a lot of stock. So we got in effect a high tax-efficient yield. In a 2.5% 10-year Treasury world, that's a good way to win.

We (the U.S.) reward underbuilding utility power supply in the U.S. Especially in Pennsylvania, New Jersey and Maryland. We're having lots of coal utility retirements. We're not building new nukes (power plants). So power supply is getting tighter. We think this will set up a lot of power pricing volatility. Which is great for Calpine.

IBD: UnitedHealth Group (UNH) is uptrending despite modest EPS results. What's your view?

Peters: They got hit with negative earnings revisions due to ObamaCare. But the stock was cheap enough to withstand it. Now estimates have stabilized. They have growth in services, growth in their core managed care side. Mixed with low valuation and better earnings as we look into 2015, it will result in a nice stock. A low valuation lets you be timing agnostic.

IBD: When didExpedia (EXPE) look like a value play to you?

Peters: We bought it last fall when it stumbled on earnings last summer. It became very cheap.

I met management in the fall and became comfortable that they had gotten their technology platform in good enough shape to manage pressure fromPriceline (PCLN). I felt we should see positive earnings surprises against a lower bar.

And we think the online travel space is a good cash generator.

IBD: What do you like about truck and parts makerPaccar (PCAR)?

Peters: Trucking capacity is getting tight. You can't get drivers. And the (national) fleet is getting old, so it's set for a replacement cycle in a big way. That's building a big fundamental tailwind for Paccar. And they're good about capital allocation.

IBD: Dr Pepper Snapple (DPS) is uptrending, so why do you still like it?

Peters: They've done a good job turning no top-line growth into bottom-line growth by smart capital allocations. And they're buying back a lot of stock well below its business value.

They've driven profit margins higher and rationalized their business. Also -- and this bothers me a little -- people have been looking for domestic plays. Dr Pepper is a North American beverage play unlikeCoke (KO) andPepsi (PEP). Its valuation is getting less attractive. But we're still holding it.

IBD: What bothers you about investors liking U.S. stocks?

Peters: We try and find uncrowded games, and the U.S. is seen as the safe zone right now. That may be true, but high investor expectations and crowding make it a risk.

IBD: Wells Fargo (WFC) has met or topped consensus expectations in recent quarters. What else do you like?

Peters: They're incredibly well managed. After their last stress test regulators said basically that they can return about 100% of their earnings to shareholders if they want to, which is unprecedented, withCitigroup (C) hanging out at zero. And they're dominant in the mortgage market. Return on equity is well into the double digits. They're selling below business value. And if we get higher interest rates, that's going to be good for large banks and life insurers.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Mutual Funds

Referenced Stocks: AAPL , CELG , HAL , BRCM , QCOM

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