This firm casts a wary eye on the post-Katrina investment landscape.

    Even though the stock market managed to right itself after Hurricane Katrina, portfolio manager Wendell Perkins fears that investors will be feeling the reverberations of the natural disaster long after the streets of New Orleans are dry and cleared of debris.

"It's really too early to know the long-term impact, but I believe there is certainly the potential for a bleaker scenario if the economy slows down more quickly than people expect," cautions the director of equities at Johnson Asset Management and the manager of the JohnsonFamily Large Cap Value Fund.
    Perkins was surprised by the resiliency of the stock market immediately after the hurricane, and he attributes it to anticipation by investors that the Fed will step in to control the economic impact of rising oil prices by keeping interest rates at current levels, or lowering them. But even that may not be enough to motivate people to boost the economy by reaching into their wallets. "The rising price of oil typically takes a year or so to filter through the economy, and it seems likely it will be a drag on economic activity," he says.

Concerns about rising oil prices prompted Perkins to position the fund defensively even before the disaster. In the transportation sector, he favored railroad companies over truckers because of their lower fuel costs. He was also light on companies that rely on discretionary spending, such as those in the restaurant, entertainment and media industries.
    The only stock he sold immediately after the hurricane was property/casualty insurer St. Paul Travelers, because of its significant exposure in the Louisiana market. "The stock was only down a few dollars from its peak and I hated the idea of selling it," he says. "But I decided I didn't want to ride the risk."
    His pre-Katrina outlook for the stock market envisioned 6% to 8% returns, about in line with corporate earnings gains. At best, that's what he's still hoping for in 2006. "Price-earnings ratios aren't cheap, and it's hard to argue that investors will price stocks at a higher premium," he ways. "What we're left with is an earnings growth expectations market. This is not a time to be taking risks."

Making Small Bets

Aversion to risk is one reason Perkins likes to make clusters of small bets, rather than a few big ones. The fund usually owns between 50 and 55 stocks, with each typically accounting for between 2% and 3.5% of fund assets. Stocks that move beyond that outer boundary are usually trimmed back. He may also sell if a stock becomes fully valued within its sector, a company's financial picture is deteriorating, or if a near-term catalyst he anticipated fails to develop.
    Perkins doesn't make huge sector bets, either. A sector's weighting can vary anywhere from two-thirds to one-and-one-half times its presence in its benchmark, the Russell 1000 Value Index. So a sector that has a 10% weighting in the benchmark may comprise anywhere between 7% and 15% of fund assets.

Despite its index-based construction, Perkins maintains that this isn't a quasi-index fund. "The largest holding in our benchmark is Exxon Mobil," he says. "It accounts for over 6% of the index right now and we don't own a single share of it. The way we try to add incremental value is through stock picking."
    To select stocks, Perkins screens a universe of about 900 companies with more than $4 billion in market capitalization and assigns each to one of 20 industry sectors. He values each stock based on sector-specific valuation parameters, then filters for quality using factors such as low outstanding debt, free cash flow and stable earnings estimate revisions.

Following those initial screens, Perkins looks for a catalyst that is likely to improve shareholder value. Typical catalysts include corporate or industry restructuring or consolidation, new product introductions, changes in competition or the sale of unprofitable divisions.
    The result of this measured approach is a fund that takes a strong cue from its Russell benchmark, with some deviation. Its value orientation, however, has given it a significant performance advantage over the S&P 500 Index and other broad indexes for much of its seven-year history.
    That wasn't always the case. Johnson Asset Management, a division of consumer products maker S.C. Johnson, launched four mutual funds in 1998 as a convenient and easy way for employees to invest retirement money under the umbrella of the Johnson name.
    Those who doubted that the same company that made furniture polish and sandwich bags could manage money were equally skeptical about the funds' value orientation at a time when growth stocks were in fashion. "We were in the most undervalued parts of the market, and it was a terrible, terrible time to be launching value funds," recalls Perkins.
    Although the market began loving value stocks again as the new millennium began, moving beyond the captive audience of employees continues to present a challenge. "We've had some success in the advisor market, but it takes time to build assets," says Perkins. "I think the thing that separates us is that we don't stray from our value style. We don't always have the best numbers out there, but we do have a pure and disciplined investment process."
    When the fund does stray from its benchmark, it is because Perkins thinks he can improve performance by emphasizing companies that he believes will do well, while paring those that could underperform. Concerns about an economic slowdown arising from higher oil prices have led him to favor recession-resistant health-care companies. With their prices depressed because of ongoing concerns over government intervention and regulation, stocks in the group have adjusted to fit squarely into his value parameters.
    "Health-care stocks are trading at 12 to 14 times earnings, their most attractive levels in 15 years," he says. "But I think they may be bottoming out at this point. Their pipelines are looking better than they have in years, they are cash cows and they have great balance sheets."

Wyeth, which he began purchasing after the stock plunged over investors' concerns about litigation surrounding its infamous diet drug, Phen Phen, is one of his favorite stocks in the group. "The company is close to having that nightmare settled. It has the right blend of current products on the market that do not have patent expiration issues, and it has a good stage three pipeline."
    The fund is also overweight in services companies, which Perkins calls a "hodgepodge of stock picker's stocks." A recent buy in the group, Accenture, came under pressure when the management consulting firm's mission to modernize the U.K.'s National Health Service hit some snags and took longer than expected. Perkins believes Accenture has resolved most of the problems associated with the project and, at a price of just 15 times earnings, its stock is a relative bargain.

Another recent buy, Gannett, is a contrarian play among newspaper chains, most of which are plagued by slumping ad sales. Perkins says that unlike most of its competitors Gannett, which owns USA Today as well as more than 100 mostly small local daily newspapers, is seeing stable circulation and positive ad growth.

The fund is underweight relative to its benchmark in the energy and utility sectors. "The problem with energy is that you need to get both the price of the commodity and individual company selection right," he says. "If you get either one of those wrong you can get killed." Perkins, who usually maintains a neutral weighting in energy, has made two major exceptions to that rule. In 1998, when oil was selling at just $10 a barrel, he beefed up the position. Today, the fund is underweight in the sector for the first time since it was founded in 1998.
    Perkins is concerned about the volatility created by the abundance of momentum players trading energy stocks. Despite its underweight position, he says the fund has been able to benefit from rising oil prices because the energy stocks it owns, such as Chevron, ConocoPhillips and Anadarko, are highly sensitive to changes in oil prices.
    He's also skeptical about prospects for utility stocks. "The average utility stock in the U.S. trades at 16 times earnings. That's just too expensive for low-growth companies. There is an enormous disconnect here between valuation and growth." Perkins says that even though investors have been willing to pay a lot for attractive dividend yields, they are likely shift toward fixed-income alternatives for income as yields on those securities increase.

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