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)
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
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
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