Managers of $1.2 billion Neuberger Berman Guardian Fund think
of themselves as people looking to buy businesses.
When they find prospects, they kick the tires. "We evaluate
business plans and try to find plans that are best positioned for
secular growth," said senior manager Arthur Moretti. Lately that
process has brought the fund back to its winning way.
The fund was up 18.08% for the 12 months ended April 30. That
outperformed 96% of its large-cap growth rivals tracked by
Over the past three and 10 years the fund ranks in the top 42%
and 23% of its peer group.
This is a rebound from 2011 and 2012 when the fund topped only
42% and 24% of its direct rivals.
Moretti, 49 years old and senior helmsman of the fund since
Dec. 31, 2002, talked shop with IBD from his office in
What are you doing differently than you did in 2011 and 2012?
When you peel back the layers of the onion, it was the fourth
quarters in those years, not the whole calendar years, that gave
us trouble. There was dramatic risk-off trading, driven by events
that had nothing to do with stock fundamentals.
In Q3 2011, we had the budget crisis in the U.S. Then people
worried about European banks. So in Q4 investors went toward
yield. High-dividend-paying stocks did well.
Our yield then and now is less than the market's. The free
cash flow of our portfolio is above the market's, so our
companies can pay but they choose not to. They invest their money
in mergers and acquisitions or in plants or equipment. But the
market didn't care. It wanted safety, yield.
The other thing was that in 2012 we did not haveApple (
). Apple took off. It became a phenomenon. It was a driver of the
index because of its size. And not owning Apple was a head wind
We missed Apple five years ago. But by 2012 we felt the
opportunity was overplayed and we didn't change our stripes.
We've done well since late last year because the market
started to focus more on company-specific fundamentals.
What do you think about Apple now?
I have an aversion toward boxes in tech. A lot of the
intellectual property that drives disruptive change in the tech
space does not come from boxes in the long run. There may be some
innovation at that level. But the box gets commoditized. The box
does not drive innovation. It gets copied and the value
proposition of its innovator gets diminished.
The innovator gets a premium price for its innovation. But to
maintain that premium, it has to keep innovating at a level that
is as disruptive as its initial historic innovation. Otherwise it
starts to see price compression.
We saw it with Digital Equipment, withNokia (
), Compaq, Research in Motion, nowBlackBerry (
) and all the router companies that existed in the late 1990s. We
saw it with the mainframe, the super computer, the mini.
Apple has other things going for it, but now they're the big
incumbent. It might be a good trade at these prices. But the
challenges they face in the near term probably have some
box-maker elements (of failing to maintain disruptive innovation)
I talked about.
Describe your overall approach, please.
We try to think like owners of businesses. We are inherently
long-term in focus. We evaluate business plans and try to find
attractive secular growth characteristics. In each sector we own
what we see as the industry leader and the company in the best
position to grow at a premium to its peer group.
That pickiness is reflected in your concentrated approach, right?
You usually have 30 to 40 names?
Yes. We try to find industry leaders positioned to outgrow peers.
If you have conviction around their earnings power, we try to buy
them when they're statistically cheap.
You don't apply one discount to fair market value, do you? You
look for various discounts in different sectors and situations,
Right. Our value bias depends on revenue stream, type of business
and so on.
Do you look for fallen angels?
As we go through our process, we know the name we want to own. We
just don't know when the risk-reward for the stock will make
What happens typically is that there may be a valuation event.
News or some dislocation. Once it makes sense from a risk-reward
perspective, we introduce it to the portfolio.
We're not contrarian. We know the names we want. But we want
to be valuation sensitive about when to buy.
Are all of your buys on the heels of some dislocation?
It's probably 40-60. Forty percent of the time there's some
dislocation and we react. Sixty percent of the time our research
gives us a different perspective of what a company's earnings
potential can be. It looks steeper to us, so we buy.
Do you play macro trends?
We look for key risks a company may face in executing its
business plan. The way macro factors impact our process comes
from how we think macro risks may keep a company from executing
So what types of stocks are you avoiding these days?
The thing that's unique about the period we live in is that the
globe has a debt problem. It's of a scale no one has seen before.
And it's primarily focused in developed nations. It creates a
head wind for growth.
It makes businesses cautious about spending and hiring. It
makes consumers deleverage and cautious about spending.
So what are you avoiding?
We don't want businesses that depend on the capital markets for
funding and growth. Those markets have closed several times in
the past four years.
We don't want companies with a lot of debt or negative free
cash flow. For example, utilities don't generate free cash. They
have to access the capital markets to fund their businesses and
to grow. They pay high dividends and many perceive them as stable
and safe. They have large regulated revenue streams. But the fact
they can be shut out of capital markets makes them riskier now
than they have been historically.
Or say we get inflation. A utility has no control over its
revenue. It must go to a regulatory body for a rate increase. And
sometimes that decision is politically driven.
What's another industry you're avoiding?
Money center banks and brokerages. They need regular access to
They also face regulatory risk. Dodd-Frank is law, but the
implementation rules are still being written. So those financial
institutions don't know how much capital they must hold and which
businesses they can be in. Because of that, we don't know their
long-term earnings potential.
Yet financials were your largest sector at 24% of assets as of
Feb. 28. What do you have besides banks and brokerages?
Those risks create opportunities for businesses such as
exchanges. We ownCME (
) andIntercontinentalExchange (
). Both are beneficiaries of a changing regulatory backdrop.
Since the financial crisis, the thrust of regulatory reform has
been around higher capital standards and transparency.
Broker-dealers make markets upstairs, away from exchanges, in
derivatives and things that weren't exchange-traded like exchange
swaps. People didn't know where the risk is.
In the new world, regulators want to centralize transactions,
measure them and control risk. So, much activity previously done
upstairs is being compelled to be done on an exchange, where
things are centrally cleared, measured and monitored. The
exchanges benefit from that.
Yet you've gotBlackRock (BLK). What do you like about the giant
When we first got involved, asset managers were under a lot of
pressure. We first purchased in the fall of 2010 whenPNC (PNC)
andBank of America (BAC) opted to materially reduce their
positions to raise capital. BlackRock stock had underperformed in
the market's rally off its 2009 low. The share price pressure
created by these two sellers set up an attractive risk-reward in
And they have a set of active equity products and a set of
passive strategies. So they are somewhat uniquely positioned to
grow their assets regardless of which way investors' preferences
You've also got insurers. Why do you like them?
Auto insurance is like advertising. It's not something everyone
thinks would be an inflation hedge. But policies are written for
(a set time period). If they're not profitable, the insurer stops
writing that business. It writes new policies with higher rates
that give them a good return on their investment. We
ownProgressive (PGR), which we think is the most innovative. We
ownBerkshire Hathaway (BRKB), which owns Geico.
What else do you like about Berkshire?
We bought Berkshire late last year. About 70% of its value was
driven by its industrial businesses. Many are the best in their
class. We like that. They own Burlington Northern (BNSF Railway),
Why do you like names such as that?
We see head winds to growth. So we want financially strong
businesses, with strong free cash flow and strong balance sheets,
which can fund their own growth.
And we want companies that can protect our purchasing power if
we get policy-induced inflation down the road. Companies that
have big distribution, logistics elements to them inherently let
you pass through price increases.
One example is things like railroads -- Burlington Northern.
They also benefit from the industrial renaissance being fueled by
growing U.S. oil and gas supplies.
Other examples are less obvious, like advertising. Ads are a
form of distribution model. We ownScripps (SNI) andGoogle (GOOG),
which make money from ads.
Only some consumer staples fit this (distribution model) as
well. We never owned consumer staples through 2008. We started to
buy ones with strong brands that grew earnings in the worst
environment ever. We think those companies have already been
What are some examples?
Ecolab (ECL) andPraxair (PX).
Ecolab provides things consumers would recognize in public
bathrooms, such as soap and soap dispensers, disinfectants,
cleaning supplies. And they provide services. They not only sell
branded goods, but they deliver the goods to restaurants, office
buildings, commercial and industrial establishments. They also
bring them inside and install them.
One of their growth drivers comes from their 2011 purchase of
Nalco, a water purification and treatment business.
Praxair sells industrial gases for consumer and manufacturing
applications. Their industrial gases make industrial processes
more energy efficient and they cut emissions. They typically have
a facility on-site at a large customer. They also have the
capacity to package industrial gases to other customers in the
area from that facility. They pass wholesale costs for natural
gas and electricity through in their price. They get good secular
growth even in a slow-growth world.