A contrarian has no trouble finding value, but the big picture concerns him.

    Colin Ferenbach is betting on out-of-favor growth companies to stand up to what he sees as the convergence of forces that threaten to drive up inflation, weaken the economy and set the stage for a stagnant returns.
    "The market is smarter than all of us," says the 71-year-old manager of the Tocqueville Alexis Fund. "And what it's telling us is that there is not a lot to be optimistic about."
    Foremost among his concerns in what he calls a "troubling market" is the war in Iraq which, despite assurances from supporters, does not appear to be drawing to a successful conclusion. "Governments pay for wars by printing money, and my concern is how that will impact inflation," he says.
    Real estate mania, a growing budget deficit and higher energy prices also point to an inflationary environment. "High oil prices are like a tax imposed on all of us by foreigners, and they've already become a big burden for people without a lot of discretionary income."
    Yet investors seem to be relatively unconcerned about higher prices and their impact on the economy. The resilient behavior of the bond market in the face of rising shorter-term rates is a "conundrum" that defies explanation, he says.
    Ferenbach has more leeway than most managers to adjust to market conditions. The fund's mandate allows him to invest in companies of any size, as long as they have outstanding stock worth at least $1 billion. In the past, he has capitalized on that flexibility by loading up on stocks of small and mid-sized companies as well as larger ones. The fund's average market capitalization of $17 billion is less than half of the $36 billion average market cap of its Morningstar large-blend peers.
    Lately, however, larger company growth stocks that have fallen out of favor tend to catch his eye. "We're finding big name growth stocks that are not popular, and that's what whets our appetite," he says. "These stocks are cheaper than they've been in a long time, yet the companies are large, dominant players in their industries. It's hard to say exactly why leading companies like Cisco and Dell are out of favor."
    Recent buys reflect Ferenbach's penchant for siding with market castoffs. They include insurer American International Group, whose widely publicized violation of accounting regulations and questionable financial reporting to auditors and regulators has beaten down the stock. The announcement of longtime CEO Maurice Greenberg's resignation earlier in the year did little to alleviate investor concerns, and the company remains vulnerable to continued probes from regulators, fines and penalties, shareholder lawsuits and changes in management.
    Ferenbach began buying the stock in May, soon after the company's disclosure of more complete findings from an extensive internal review revealed the extent of its accounting mishaps, kicking the stock down even further than it had already fallen. He believes that despite the negative revelations about accounting policies, AIG's position as one of the strongest and most dominant franchises in the insurance industry will enable the company to overcome the significant obstacles it faces. "This is a dominant powerhouse that has just been oversold," he says. "At some point, the controversy will blow over. In the meantime, we own a great company selling at just 12 times 2005 earnings."
    Sepracor, another position Ferenbach initiated recently, represents perhaps an even bolder bet, on a biotechnology firm with a less storied past than AIG but a more tenuous market position. The company, which has licensing arrangements with major drug makers such as Schering-Plough and Sanofi-Aventis, has made a substantial investment to transform itself from a licensing partner with a trickle down revenue stream to a pharmaceutical company with broad distribution capabilities.
    On the downside, Sepracor has a long history of negative earnings and cash flow, and a short track record marketing its own limited roster of proprietary products. One asthma drug accounts for most of its sales. Its other major offering, the sleeping aid Lunesta, is just getting off the ground and faces competition from Sanofi-Aventis' Ambien and planned launches of other sleeping aids by major pharmaceutical companies.
    But Lunesta is the only sleep medication approved for long-term use by the Food and Drug Administration, and Ferenbach thinks it could be a "blockbuster." He predicts Sepracor will become profitable as early as next year, about a year ahead of most analysts' projections.

REITs To Regional Banks
    Ferenbach does not distinguish between growth and value, preferring instead to compare a stock's valuation to its historical norm or to industry averages. Top ten holdings span the valuation spectrum and include General Growth Properties, a mid-cap REIT, a regional bank, computer giant Dell and a couple of foreign stocks.
    While he categorizes himself as a growth-at-a-reasonable-price investor, he emphasizes that "the term reasonable is a flexible one. We'll buy companies with higher price-earnings ratios if they have good growth prospects or something unique about them." He usually prefers companies that have grown earnings at least 10 % annually, although a few holdings have not turned a profit yet but have other appealing characteristics such as a promising or unique product. A common characteristic among the portfolio's eclectic collection of 45 or so stocks is that Ferenbach purchased them after their prices had dropped on bad news, or they had been out of favor for awhile.
    In addition to buying stocks on the cheap, Ferenbach also tries to limit risk by capping individual positions to no more than around 3% of assets and selling when a stock has hit his price target. The approach has generally worked best in choppy markets such as 2000, when Ferenbach lowered the fund's stake in pricey technology stocks ahead of the brutal sell-off. But a discipline for taking gains off the table when he thinks a stock has become overpriced has also limited gains when the market surges. "When people are throwing money at stocks we tend to lag," he admits.
    Ferenbach finds regional banks intriguing, and at 18% of assets banks represent the fund's largest sector weighting. He believes the regionals "are well-positioned to be acquired, understandable, and small enough to be manageable." Holdings include Mercantile Bankshares, which has a strong presence in the Baltimore-Washington, D.C., area, M&T Bank Corp., which operates out of Buffalo, and Milwaukee-based Marshall & Ilsley.
    Technology hardware and equipment companies account for 15% of assets and represent the fund's second largest industry weighting. While the fund's technology giants have "done okay" over the last couple of years, Ferenbach thinks the best is yet to come. "When you think of routers you think of Cisco, and when you think of chips Intel immediately comes to mind," he says. "These are some of the strongest brand franchises in the world that have no debt and huge piles of cash, and they are on sale."
    He continues to own pharmaceuticals such as Johnson & Johnson, a core holding since 1994, and he added Pfizer to the mix about six months ago. Despite the industry's pricing and regulatory issues, he thinks growth prospects for drug makers remain solid because of their leadership position in the global market.
    One of the fund's best performers lately has been publisher John Wiley, a small, family-controlled publishing firm with strong ties to major distributors like Barnes & Noble and Amazon. Ferenbach has owned the stock for about 18 months. With the surge in oil prices the fund's energy holdings have also done well recently. But Ferenbach has been paring his position in the sector because of concerns about a drop in oil prices, and the fund only has about 6% of its assets there. "Fifty dollars for a barrel of oil is a crazy and unsustainable price, and $60 is even crazier," he says.
    Disappointments this year include 99 Cents Only Stores, a deep-discount retail chain. The company has struggled with an expansion from its core California market into Texas that has been more difficult than expected, and increases in labor, distribution and other costs have cut operating margins. Ferenbach continues to hold the stock, however, because he believes management is taking steps to improve the company's financial picture and is putting the brakes on its ill-fated Texas expansion. Stagnant prices for some commodities make him less optimistic about prospects for stocks like Alcan Aluminum, a position he eliminated from the portfolio earlier this year.
    On a broader scale, the unexpected strength of the dollar against the Euro during most of 2005 has diminished the value of a currency hedge represented by the fund's 20 % stake in foreign stocks, which includes top ten holdings Hannover Rueckversicherungs and Total S.A. "I've been wrong this year about the direction of the dollar," says Ferenbach. "The foreign exchange market is driven by many unpredictable factors. But by and large, foreign markets remain attractively priced relative to the U.S."