To reduce volatility in the U.S. mid-cap growth space, Brian Berghuis, a vice-president and portfolio manager at Baltimore-based T. Rowe Price, draws on three pillars of discipline that span 27 years.
“The first,” says Berghuis, lead manager of the gold-rated TD US Mid-Cap Growth D Series says, “is to, over the long run, provide value by beating whatever mid-cap benchmark someone cares to apply. Secondly, the area is fairly volatile and we aim to be less volatile than the area as a whole. And third, we want to apply a consistent investment process over time.”
That risk-averse strategy is evident in the positioning of the fund today. “This is a difficult market,” says Berghuis. “In the last couple of quarters, growth has been decelerating here in the States and investors have been piling into companies oftentimes with no earnings but with high sales growth.” This movement spans a number of different areas, but “technology would be the epicenter of the overvaluation.”
Some aspects of today’s market echo the internet bubble period. “I think it’s not nearly as amplified as it was back then,” says Berghuis, “the companies are real companies, but the valuations in some areas are really, really extended.” So leery of the technology space, the fund has reduced its weighting in the area.
Lighter on tech, heavier on diversification
Based on bottom-up, fundamental analysis, the fund is currently weighted around 23% in technology. According to Berghuis, the Russell Mid-Cap Growth Index is about 10 points higher, “so relative to the benchmark, we’ve very underweight.” Other risk measures include broad diversification among the numerous 120 to 150 holdings.
Research includes an emphasis on meeting management teams and assessing business models. The screening process focuses on solid companies with durable growth and reasonable valuations that will sustain business cycles.
Going against the crowd is reflected over time. During the period from 2006, running up to the financial crisis in 2008 and 2009, Berghuis says there was a headlong dive into sketchy real estate investments and some fairly speculative issues. “We pretty much got out of anything that was real-estate related,” says Berghuis, “and quite early, in 2005. We thought the market was pretty frothy and we stuck to our guns.”
The stock criteria in the U.S. mid-cap range, as defined by the firm, spans $4 billion to $35 billion equity market capitalization. Secondly, as a growth fund, the investment team looks for companies that they think can grow their earnings or their cash flow by 12% over the course of a business cycle. “Sometimes it’s a stretch,” says Berghuis, “to get to 12% given the much slower growth economy here since the great financial crisis.” In the market environment, the focus is on companies that are more attractive on a relative basis that meet the long-term investment philosophy.
Berghuis’s bets
Ball Corp. (BLL) among the top 10 holdings, a leader in beverage cans and products, is one such company. “Ball,” says Berghuis, “ticks off a lot of the criteria that we look for. It has a management team that we think is outstanding and a large customer base in a consolidated industry, so that’s important.” The production of smaller, speciality-sized cans is also seen as profitable and having growth potential. According to Berghuis, cans are slowly taking market share from bottles, especially plastic. “Aluminum cans are probably the most recycled material out there,” says Berghuis, "so it appeals to a lot of people who are environmentally conscious.” Fundamentally, Ball is strong as well. The company has very large free cash flow, good earnings growth, and an improving balance sheet, all characteristics that the investment managers look for.
Hologic Inc. (HOLX), also among the top 10 holdings, specializes in medical technology imaging, primarily in women’s healthcare. According to Berghuis, Hologic is a leader in the market across different product lines and the clear leader in imaging in mammography. “There’s been a significant upgrade,” says Berghuis, “in imaging technology over the last five years, going to 3D, with a much, much better detection rate. I feel the products are leaders, the balance sheet is good, they generate a lot of cash flow and can compound earnings over the long run.” The company is also favoured for its decent valuation.
Another classic T. Rowe mid-cap growth stock is Dollar General (DG), founded in 1939. “Dollar General is the largest dollar chain in the U.S.,” says Berghuis, “ operating mostly in small towns. The company is favoured for its strong management team, its ability to grow its store base each year, and a track record of earnings growth and good cash flow. “And I would say that dollar stores are the most durable retail concept that was ever invented in the United States,” says Berghuis. “Think of all the retail concepts that have come and gone over 80 years.”
With a long-horizon strategy, Berghuis says the mandate has a fairly low annual portfolio turnover for a growth fund, typically in the 25% to 35% range. Some companies have been held in the portfolio for over 20 years.
Looking ahead, “it’s a difficult environment,” says Berghuis, “and we’re positioned a little bit more cautiously than our benchmark. But bear in mind, the Russell Mid-Cap Growth is very, very aggressive: it takes up a lot of high-price momentum stocks. So when I say that we’re positioned cautiously, it doesn’t necessarily imply that we’re positioned cautiously relative to the overall market. I don’t want to imply that this is a conservative equity fund, because it’s not.”
Morningstar View
Brian Berghuis is one of the nominees for the Morningstar Awards for Investing Excellence--Outstanding Portfolio Manager for his fund T. Rowe Price Mid-Cap Growth. We believe he is one of the industry's best and longest-tenured managers. Morningstar analyst Alfonzo Bruno points out that Berghuis benefits from excellent analytical resources at the firm, but has been the steady driver behind the fund's success for 27 years. Berghuis has stuck to a consistent approach that focuses on companies with good business models, differentiated products, capable management teams, and growing returns on invested capital. He builds the portfolio with a risk-conscious mindset and a tilt toward quality. For instance, Berghuis' cautious approach helped the fund avoid blowing up when the tech bubble burst in the early 2000s, and it also held up relatively well during the 2007-09 financial crisis. Meanwhile, the fund regularly owns plenty of nonbenchmark positions, which has helped distinguish it from cheaper passive options over his tenure.
