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Batterymarch U.S. Equity

Last year the Batterymarch U.S. Equity fund, formerly known as the Perigee U.S. Equity fund, fell 19.8% compared to the S&P500 Total Return index's 24% loss (expressed in Canadian dollars). The absolute scale of the loss notwithstanding, this was a top quartile performance which shows how bad the year was for most investors. By the end of June the fund was down 4.4% since the start of the year, while the index was down 4.1%. Market gains south of the border were more than offset by the sharp rise in the value of the Canadian dollar during the first half of the year.

The fund missed out on much of the market run-up of the late nineties and it started to lag the S&P 500 in 1996. As a result, the fund's ten-year average annual return of 6.9%, although above average, is modest against the index's 10.6% performance. To be fair, only a small handful of actively managed funds managed to outperform the index over that period. Also, in this instance, the record of past performance is a particularly poor indicator of future performance because the fund recently underwent a change in management. Since the management change, the fund has closely tracked its benchmark index.

Boston-based Batterymarch Financial Management Inc. (BFMI) has handled the day-to-day operations of the fund on behalf of Perigee since July of 2001. Both BFMI and Perigee are subsidiaries of Legg Mason Inc. The fund's management team selects stocks of large and mid-cap U.S. companies using what amounts to a bottom-up growth-at-a-reasonable-price (GARP) style.

At the heart of BFMI's quantitative approach is a ranking that uses a range of fundamental measures. This ranking is applied to 3,000 stocks on a daily basis. The 100 stocks with the largest market capitalisation, called the "Top 100", are always held by the fund. Of these 100 stocks, the top ten by rank are identified for additional purchase while the bottom fifty are marked for paring back. Stocks outside the "Top 100" are bought or sold on the basis of their quantitative ranking.

Portfolio construction uses the S&P500 index as a benchmark. Sector weightings are kept within a 5% band around the benchmark weights and cash is limited to 3% of assets. Stocks are kept below 0.5 times their benchmark weight, except for the "Top 100" stocks. These can have as much as 1.5 times their benchmark weight, depending on their attractiveness as determined by their quantitative ranking.

Given its rules-based scheme, which is updated daily, it is clear that the fund doesn't take a long-term outlook with regards to its stocks. This is nothing new for the fund, which has often recorded high turnovers. Indeed, during its first full year under BFMI's management the fund had a high 134% turnover but this is slightly less than the 143% average of the previous five years.

Not surprisingly, when it is considered in aggregate, the fund's portfolio has characteristics similar to the S&P500 index. Its earnings yield of 5.0% translates to a P/E ratio of 20, similar to the 21.7 of the index at the end of the quarter. A dividend yield of 1.7% also compares favourably with the index, which had a 1.2% yield. However, on a price-to-book basis the fund was slightly more expensive with a ratio of nearly 3.0 compared to 2.5 for the index. Of course, from a strict value perspective, the portfolio is fairly expensive.

At the end of the second quarter the fund held 157 stocks and a 0.9% cash position. The top three sectors in the portfolio were Financials, Information Technology, and Health care. Together these made up nearly 60% of the fund. The fund's top three individual holdings were Microsoft, Exxon-Mobil, and Citigroup. During the quarter, the fund eliminated twenty-two positions including Pharmacia, Symantec, and The PMI Group. Thirty new stocks were purchased, including Best Buy, Commerce Bancorp, and Adobe Systems. Changes to existing positions included a significant expansion of the fund's exposure to Chevron-Texaco and a reduction in Procter & Gamble.

Going forward, overweight positions in banks, software, and technology will be maintained, as will an underweight position in retailing. The managers are cautiously optimistic about the prospects for both an economic recovery and a sustained turnaround in the markets.

One concern worth noting is the possibility that the fund essentially replicates the index, but with a much higher fee than a S&P500 index fund. Although the relative weightings of stocks in the fund and in the index are likely to be different, the strong overlap between the list of "Top-100" stocks and the largest components of the S&P500 does raise the spectre of closet indexing. With only a two-year record, it is too early to tell whether BFMI's stock selection strategy will add significant value in the long run.

With this caveat in mind, if you're looking for an index fund, then there are many worthy candidates. However, if you want the potential value added of an actively managed fund then the Batterymarch U.S. Equity fund provides it for a comparatively low 1.4% MER and a modest $2,500 initial investment. The fund is suitable for the foreign equity holdings of frugal investors.

FF: Q2 2003



Disclaimers: Consult with a qualified investment advisor before trading. Past performance is a poor indicator of future performance. The information on this site, and in its related newsletters, is not intended to be, nor does it constitute, investment advice or recommendations. The information on this site is in no way guaranteed for completeness, accuracy or in any other way. More...