The weak economy has made Phillip H. Perelmuter, the manager of the US$1.4 billion Hartford MidCap fund, even more selective than usual.
"Because economic times are tough, if a company's fundamentals aren't good the economy won't bail it out," Perelmuter said from his office in Boston. As a result, he said, "We're looking for new management coming to midcap companies and accelerating revenue and earnings growth because of their internal improvements."
The fund lost 8.4 percent a year, on average, for the three years through March, adjusted for its 5.5 percent front-end sales load, or sales charge. It still ranked among the top 6 percent of all midcap growth funds, which lost 23.6 percent, annualized, during that time, according to Morningstar Inc. The Standard & Poor's 500-stock index, meanwhile, was down 16.1 percent, annualized.
The fund lost 24.1 percent, adjusted for the load, in the 12 months through March, compared with declines of 28.7 percent for its group and 24.8 percent for the index.
Perelmuter, 42, is senior vice president of Wellington Management, the subadviser of the fund for Hartford Financial Services. He manages a total of $3.8 billion for institutions.
For the fund, he focuses on about 250 companies with market capitalizations of US$2 billion to US$10 billion that hold leading shares of their markets.
To pick the 90 to 100 stocks in the portfolio, he looks at longer-term economic and demographic trends. The aging of the population, for example, has led him to load up on health care stocks, which account for 19 percent of the fund's assets, compared with 13 percent for his benchmark, the S&P MidCap 400.
Perelmuter uses three approaches to calculate a company's worth. First, he compares its current and two to three-year projected price-to-earnings ratios to those of other companies in the index. To factor in the company's balance sheet, he looks at its ratio of enterprise value -- which he defines as its market capitalization plus its net debt -- to Ebitda, or earnings before interest, taxes, depreciation and amortization. Finally, he reviews price-to-cash-flow ratios to assess capital spending and working capital.
Perelmuter asks executives at candidate companies to describe long-term trends in their industries, and how they plan to benefit from or minimize the impact of those trends. He also asks what is most misunderstood about the company, its industry or its products.
It is important for companies to have a simple mission, he said.
"We like companies that are focused on one business, not conglomerates with lots of businesses."
When he decides on a stock, he typically starts with a position of no more than 0.5 to 1 percent of the fund's total assets, adding shares as his confidence builds but generally not exceeding 2.5 percent of assets. He reviews a company's shares for sale when management changes or its fundamentals deteriorate.
Perelmuter started buying shares of Watson Pharmaceuticals, a producer of generic and brand-name drugs, in March 2002. He has paid US$27.83, on average, for his position; the stock is now at US$28.39.
The initial purchase was made after Watson missed its earnings target in the fall of 2001, after about a decade of steady revenue and earnings growth, and its share price dropped to less than US$30 from more than US$50. He added significantly to the position when the company named Joseph Papa to the position of president and chief operating officer in the fall of 2002. Watson's revenue should accelerate, Perelmuter said, because of the Food and Drug Administration's approval in February of its new product, Oxytrol, a patch used to control incontinence.
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