The markets gave us a good ride in the third quarter as the
S&P 500 turned in its best September performance in decades.
But it's important to remember that domestic economic growth is
likely to be lackluster for some time. In such an environment
it's imperative to maintain exposure to steady, slow-growth
companies that will turn in good results quarter after quarter,
regardless of the state of the broad economy.
While rising markets can make for exciting times, slow and
steady is generally what generates returns.
American Century Mid Cap Value
(ACMVX) is one steady Eddie that will reward investors over the
long term.
Working with a small in-house team of analysts, the fund's
three-man management team of Philip Davidson, Michael Liss and
Kevin Toney winnow down a universe of about 1,500 mid-sized firms
to a more manageable 500 names. They focus only on companies that
fall within the least-expensive third of the group as measured by
valuation metrics such as price-to-earnings and price-to-cash
flow.
One of the team's favorite metrics is return on capital (ROC), a
company's earnings divided by total equity and debt. That measure
gives investors a good idea of where a business lies in the
economic cycle and whether it's making the best use of investors'
capital.
Companies that don't enjoy dominant market shares are eliminated
from consideration. These companies lack pricing power and are
susceptible to downturns in their industry or the broad economy.
Given the value focus of the fund and its initial screening
criteria, management tends to find opportunities in beleaguered
businesses and industries.
The next step in the investment process is determining which
companies can maintain their dominant market position while getting
earnings back on track. The managers purchase those with the best
risk-to-reward profiles and those trading well below estimated fair
value with solid prospects for an earnings rebound.
The fund's heaviest weightings are in financials, industrial
materials and consumer goods. This investment strategy could be
considered quite risky in the current economic environment, but
management has focused on high-quality names that mitigate
risk.
The fund's holdings in the financial sector primarily focus on
trust banks such as Northern Trust (
NTRS
), which generates high levels of fee income, as well as insurance
outfits such as Chubb Corp (
CB
) and ACE (
ACE
), which offer specialty insurance products that face little
competition.
The fund's consumer-focused holdings are dominated by names that
tend to perform well throughout the economic cycle. Kimberly-Clark
Corp (
KMB
) and ConAgra Foods (
CAG
) are two such holdings.
Management executes its strategy extremely well on a long-term
basis, which is hardly surprising given their deep well of
experience. Davidson has been part of American Century Mid Cap
Value's management team since its inception in 2004 and has
followed similar strategy with a large cap value fund, American
Century Value (TWADX), since 1993.
Management adopts a cautious approach to evaluating balance
sheets, and their investments tend to lag the markets in boom
cycles and hold up better in busts. That can create swings in the
fund's year-to-year performance; in a given year American Century
Mid Cap Value can rank at the top or the bottom of its category, or
anywhere in between. However, the fund's trailing three-year and
five-year total returns place it in the top 8 percent and 6 percent
of its category, respectively.
One of the fund's drawbacks is that it's not particularly tax
efficient. Although stocks tend to stay in the portfolio for
several years, management usually scales in and out of positions
incrementally as stocks hit their price targets. That trading
activity tends to generate capital gains distributions.
Another potential issue with that level of trading is that it
tends to raise incremental costs, potentially eating away at
returns. It's probably best to hold American Century Mid Cap Value
in tax-advantaged accounts such as IRAs.
The fund stacks up well when one considers its expenses. With an
annual expense ratio of 1 percent, it's neither too expensive nor
particularly cheap. Given the value that management adds, 1 percent
seems fair.
American Century Mid Cap Value isn't a fund that will generate a
lot of excitement on the upside, but it will provide a nice cushion
when markets fall. It's best as a long-term portfolio holding
because it realizes benefits after a full business cycle.