The inflows bring the fund's total assets to more than $4 billion, making it Dreyfus' largest mutual fund by a margin of more than 25% over the next biggest Dreyfus fund,(Dreyfus Emerging Markets Debt Local Currency ). Investors are right to be drawn to this fund.
A Standout Process
One of this offering's most-distinctive traits is its low, low turnover ratio. Although recent trades caused the fund's turnover to rise in 2010 (to a still small 29%), the fund has more regularly run a single-digit turnover rate. In fact, turnover ranged from 1% to 8% from 2000 to 2009. The small amount of trading indicates that the fund's managers maintain a long-term investment horizon, but the low turnover has other benefits, including minimal brokerage commissions and other implicit trading costs as well as fewer capital gains distributions.
Low turnover, however, shouldn't’t suggest a passive, or indexlike, strategy. Although most of the fund's holdings are S&P 500 Index constituents, the fund's active share, which measures how differentiated a fund is from a benchmark, is a more-than-respectable 67.88%. The management achieves this in a couple of ways. One, it owns out-of-index names, including a generally 10% to 15% stake in foreign stocks, such as Nestle and Royal Dutch Shell . Two, it keeps a compact portfolio of around 50 names and so each position's weighting can differ markedly from its index stake. For example, Exxon Mobil is the S&P 500 Index's biggest constituent with a 3.3% weighting, but Dreyfus Appreciation puts 5.4% in that name. Conversely, both the index and the portfolio have General Electric as a holding, but the fund's stake is half the index's. As important is what the fund doesn't own at all, including index heavyweights Microsoft , AT&T , and Pfizer .
One other key differentiator is the fund's emphasis on the largest companies. The portfolio's average weighted market cap is north of $100 billion dollars, which compares with the S&P 500 Index's nearly $50 billion and the $36 billion for the median large-blend fund. The explanation for that stems from subadvisor Fayez Sarofim & Co.'s investment process. It insists on owning an industry's dominant players because they should be able to generate superior earnings growth over time. Another sought-after attributes is financial health, including the ability and discipline to pay a dividend (51 out of the fund's current 53 holdings pay a dividend). Valuation is important at entry points--the firm increased its stake in Total this year as worries over Europe created opportunities--but the fund's long-term orientation means that at times the portfolio's price multiples can creep upward.
Finally, the advisor's investment committee, made up of nine senior managers, uses some bigger-picture analysis to help determine which industries the fund will favor, though even then a very long-term orientation is in place and the fund does little rotation among industries. For most of the fund's existence, that has meant a big energy weighting; currently, that stake sits at nearly 24% of the stock portfolio, more than double the S&P 500 Index's weighting. Fayez Sarofim has a good relationship with Big Oil--its Houston headquarters has helped establish that, as many oil company managements move through the city. Today, the team thinks that strong emerging-markets demand will help fuel the sector’s fortunes. (Global growth is another theme in the portfolio.) It also appreciates the majors' high returns on capital, low levels of leverage, and dividends.
Consumer staples has been another area of emphasis that stands out, again a function of the management team's preference for dominant companies that can grow globally. Here, the managers also like those firms' pricing power and volume growth as they penetrate new markets. Consumer-defensive names, such as top-holding Philip Morris International and Coca-Cola , altogether take up nearly 28% of the portfolio, compared with 12% for the S&P 500 Index.
The Upshot
As predictable as the portfolio has been, so has been the fund's performance. It's hardly explosive--the fund's standard deviation and its Morningstar risk scores are pleasingly low compared with the competition. Not surprisingly, its long-term Investor Returns, which measure the experience of the fund's average investor, are thus actually superior to its more-commonly cited total returns--perhaps a nod to shareholders' ability to sleep at night even during market strife. Since Fayez Sarofim took the reins in late 1990, the fund's downside capture ratio, which measures how much of the index's losses the fund has suffered during down months, has been just about 80%. More tangibly, consider that although the fund lost 32.4% in 2008, that showing landed it just outside large-blend category’s best decile in a year when the S&P 500 Index lost 37%. During the tech bust that began in March 2000 through early March 2003, the fund dropped by nearly a third, while the S&P 500 Index fell almost in half.
There have been long-term, 10-year periods, however, when the fund has trailed behind its S&P 500 benchmark. In fact, over rolling 10-year time frames, the fund beats the S&P 500 Index about as much as it has trailed that index. While it holds up in downturns, it lags behind in rallies--its upside capture ratio is just under 87%. A rolling 10-year return analysis could suggest buying the fund, and paying its expense ratio, is a wash, at best, compared with simply buying an index fund--especially considering the margin of defeat or failure tends to be quite small--but on a risk-adjusted basis, the fund still looks better.
A Feather In Dreyfus' Cap
Investors might balk at investing with Dreyfus, which hasn’t had a stellar record cultivating an investment culture over the years. However, in the case of this fund, there's much to like about subadvisor Fayez Sarofim's relationship with the firm. First, this fund represents the only way to gain access to that advisor through a U.S. mutual fund. (Investors can go directly to Fayez Sarofim, but there are hefty minimum account sizes.) Second, Dreyfus has negotiated a 0.55% management fee, which is less than investors would pay directly to Fayez Sarofim (though total expenses here could be lower; the fund’s 0.99% expense ratio is average compared with large-cap no-load funds). Third, Dreyfus has maintained the fund's no-load status here. (Investors working through a financial advisor could also buy Dreyfus Core Equity , which is run in the same manner with the same portfolio managers.) Fourth, Dreyfus has not messed with this winning formula over the long history of their relationship.
From Fayez Sarofim's perspective, the arrangement is similarly important. The fund represents roughly 25% of the subadvisor's assets. Shareholders here thus gain access to a talented manager, having to pony up just $2,500 and pay a fair fee.
Although Fayez Sarofim himself is 82 years old, he says he has no plans to retire. The firm has been working on a succession plan, adding more-senior personnel to the executive and senior investment committees. These plans seem logical--Sarofim's son works with the firm, and other senior leaders have been with the firm for some time--and keep the operations largely in the hands of folks who cut their teeth on the investment side. We have enough confidence in the rest of the team to still recommend the fund even if Sarofim were to retire today.
Conclusion
Dreyfus Appreciation's record has been one featuring returns similar to that of the S&P 500 Index, albeit with less volatility--and that is an important benefit, though often underappreciated. This portfolio of who's whos can do the trick for the long term.
Arthur Levitt, during his tenure at the SEC, experienced many cases where the non-indexed mutual fund manager bought shares for their own accounts before the fund bought the shares. The fund?s purchases drove up the price of the stocks and the fund manager?s made a killing on the deal. This is called ?front running,? and is illegal under securities laws.
Mr. Levitt also witnessed instances where the funds would buy huge blocks to run up the stock price at the end of the financial reporting period. This made the fund look like it had a high profit when it did not. This makes the fund?s performance look better than it really is.
The SEC brought enforcement cases against some of the largest and most respected companies during Mr. Levitt?s tenure as SEC chairman. A mutual fund run by Van Kampen Investment Corp. for example, claimed in public advertisements that it had returned 62 percent in 1996. This information caused the fund-rating service Lipper Inc to report the mutual fund as the top performer in its class, a full 20% ahead of the second-best performing fund in the category.
But investors weren?t told that the excellent returns of the Van Kampen fund were on tiny assets of $200,000.00 to $380,000.00. This is because it was really a so-called incubator fund operating on seed money until its portfolio manager could establish a track record for marketing purposes. Nor were investors told that more than half the returns came from investments in thirty-one hot IPOs. An IPO is an ?Initial Public Offering? that occurs when a firm first offers its stock across a public exchange. Since the stock is new nobody knows how it will perform except insiders.
The fund only had to buy between 100 and 400 shares of each IPO to achieve a huge amplification of the returns. The 62% return unrealistically raised investor expectations and was unsustainable. When senior managers of Van Kampen decided to sell the fund to the public some 15,000 people invested $100,000,000.00 within six weeks. Van Kampen settled SEC charges that it had misled investors. What a bunch of con artists. The modern day mutual fund is like a remake of the movie ?The Sting? where Paul Newman?s character has been replaced by the fund manager!
A fund run by Dreyfus Corp., owned by Mellon Financial Corp., paid almost $3 million to settle, without admitting or denying guilt, similar charges of fraudulently luring investors with unsustainable returns. Its manager claimed returns of more than 80%, but failed to tell investors that the fund had received a disproportionate number of IPO shares that should have been allocated to other Dreyfus funds.
The fund industry should work less on image creation and more on making sure that it has done everything it can to safeguard investor?s money and boost returns. The mutual fund industry has become a financial powerhouse over the past twenty years and only cares about how much money it can suck out of the public just as it was at the turn of the last century when they were called investment pools. Funds are glitzy marketing operations instead of stewards of other people?s money. Don?t put your trust in them unless they are fully indexed like the Vanguard 500 (VFINX).
ABOUT THE AUTHOR: Dr. Scott Brown, Ph.D., a.k.a. ?The Wallet Doctor?, is a successful futures trader, real estate investor, and stock investor. Dr. Brown holds a Ph.D. in finance from the University of South Carolina. His 1998 articles in Technical Analysis of Stocks and Commodities were prophetic in predicting an impending stock market crash. He has helped many people become profitable investors by teaching them to look out over many years to spot stocks that are low and primed for rise in the new bull market. His second article met with approval by Dr. Bob Shiller of Yale University. Dr. Shiller is the economist that Alan Greenspan most highly regards who coined the term ?Irrational Exuberance.? In 1998 he shouted to the world to ?get out? of the stock market but now he is shouting to everyone that it is time to ?get in!? The Wallet Doctor is not only sought after for investment advice and coaching in stock investing but also in futures trading and real estate investing. Visit Dr. Brown?s site at http://www.BonanzaBase.com or sign up for his investment tips at http://www.WalletDoctor.com
Written By : Dr. Scott Brown, Ph.D.
