The fund's largest holding, Annaly Mortgage Management, typifies a defensive, bear-market-defying stock that has benefited from falling interest rates. The commercial mortgage REIT has a yield of about 14% and a history of increasing dividends, yet sells at just over eight times earnings. The stock is up 21.4% this year as of November 1.
Stocks involved in takeover activity also have fared well. Pharmacia rose 11% in the third quarter on its takeover by Pfizer and is up 10% this year as of November 1. American Water Works, another takeover play, is up 9% for the year. Several recently established positions represent special situations that should benefit from merger activity or corporate actions. These include NCS Healthcare, involved in a hostile takeover situation, and Hollywood Casino, the subject of a friendly takeover.
At 27% of assets, financial services represents the fund's largest sector weighting. Although low interest rates still make the group attractive, Luck has been trimming his positions in large money-center banks, such as Citigroup, because of increasing corporate loan losses and moving toward banks with a tamer lending profile, such as Bank of America and Wells Fargo.
Companies in the consumer discretionary category, such as those in the automobile, hotel and media industries, account for nearly one-quarter of fund assets-substantially higher than the 14% allocation for the benchmark. Luck says that despite concerns about the economy and market turmoil, the group remains attractive because consumer spending has showed surprising strength even in a weak economy. Among automakers, he prefers General Motors because of its growing earnings and strong franchise, but remains wary of Ford's declining market share and restructuring problems.
In the beaten-down growth-stock category, Luck continues to accumulate Walt Disney, which he began buying in early 2002. Although the stock has drifted downward since then because of declining revenues, he thinks the company's strong franchise and opportunities for earnings recovery make Disney "extraordinarily cheap."
Luck's interest in fallen angels like Walt Disney reflects his desire to add more reasonably-priced growth stocks to the fund mix going forward. "Value stocks are no longer a slam-dunk anymore," he says. "On a selective basis, some great growth companies have become fairly valued, if not undervalued."
SIDE BAR
Is Taming Taxes Still A Valid Strategy?
When First Quadrant Tax-Managed Equity Fund was launched in December 2000, investors were simultaneously reeling from a sudden market downturn and a year of record mutual fund capital gains distributions. "We felt there was a strong need for a solid tax-managed mutual fund offering," says Luck. "The taxable investor was not being served well by most existing actively managed funds."
Today, as prolonged market losses have created a virtual capital gains distribution drought, the argument for tax-managed investing often falls on indifferent ears. Yet Luck believes that there is still a place for tax-managed funds in taxable accounts. "Ultimately, the market will recover," he says. "So while fund taxes aren't an issue now, they almost certainly will be in the future. Investors want to be in a mutual fund where tax efficiency is a policy, not an accidental byproduct of a bad market."