Still in his early thirties, David Giroux has taken the reins of one of T. Rowe Price's most high-profile and successful funds.
T. Rowe Price is the kind of mutual fund firm that likes to introduce changes in measured steps. When it comes to performance, its portfolio managers often shoot for consistent singles and doubles rather than off-the-charts home runs, and some of them have run the same funds for ten years or more.
So it didn't come as a complete surprise when the $11 billion T. Rowe Price Capital Appreciation Fund became the poster child for reliability in December 2006, as it emerged as the only domestic equity or balanced fund to provide a gain for each of the previous 16 calendar years. During that period, it outperformed the S&P 500 stock index with an annualized return of 13.1%, compared with 11.8% for the index. The fund, a conservative value offering that mixes stocks, bonds, convertible securities and cash, has had only one year of negative returns since inception in 1986.
But at a firm where manager changes are unusual, Capital Appreciation has strayed from the beaten path. After a 12-year stint as manager, Rich Howard left the fund in 2001. Stephen Boesel ran it from August 2001 to June 2006, and Jeff Arricale and David Giroux co-managed the fund after Boesel's departure. In July, Arricale took the reins of the Financial Services Fund. The move left the 32-year-old Giroux as the firm's youngest fund manager for one of its largest, most visible offerings.
Despite his age, Giroux is a T. Rowe Price veteran of almost ten years. He cut his teeth there as an analyst after graduating in 1998 from tiny Hillsdale College in Michigan, and worked his way up the ranks to co-manager of the fund last year. He began working at the Capital Appreciation Fund in 2004 when Boesel announced his retirement. He also co-manages several of the firm's separate account portfolios and was named as one of four T. Rowe Price investment professionals to
Institutional Investor's All-American Research Team in 2005.
Having all of his 401(k) money in the fund is an added incentive to continue the fund's history of producing equity-like returns with lower risk than the stock market. Still, he admits, a 16-year history of positive returns is a tough act to follow. "My goal is to be around another 25 years, so I wouldn't be surprised if I'm the one to end the streak at some point," he says.
If he does break the streak, it won't be because of a major strategy shift. To help smooth the transition, Arricale and Giroux spoke with or visited nearly all of the companies in the portfolio during the 13 months they were co-managers. After Arricale left, Giroux didn't make too many changes. The fund still spreads its bets widely among a variety of asset classes, allowing its manager to pick what he considers their best spots in a company's capital structure. At the end of June, U.S. large-cap stocks made up about 60% of assets. Cash was the second-largest asset class at nearly 17% of total net assets, followed by convertibles and domestic bonds at about 10% each. Foreign stocks make up less than 3% of the fund because Giroux sees more value in U.S. markets, and views more speculative markets such as China as too risky and expensive.
Since the beginning of the year, the fund has shored up on bonds and trimmed stock positions Giroux considers too risky. He used late-spring market weakness to add to positions in U.S. Treasury securities and high-quality corporates, increasing the proportion of bonds from 3% at the beginning of the year to 10.2% of assets at the end of June. "At yields of 5.10% to 5.25%, bonds begin to look interesting," he says. "And because bonds have historically done well when the stock market heads south, they provide a cushion against poor equity returns." But high-yield bonds haven't captured his interest because of their credit risk and their still-slim yield advantage over Treasuries.
Cash remains a major component of his investment strategy. Even though he trimmed the fund's 20% cash position at the beginning of the year to invest in bonds, he still finds the yields on money market securities attractive enough to maintain a sizable allocation.
Among stocks, Giroux looks for undervalued companies with prospects for appreciation that investors have shunned because of earnings setbacks, unfavorable industry or economic conditions, or negative publicity. Possible indicators of an undervalued stock include a company's above-average dividend yield, a low price-to-earnings ratio or a low price-to-book ratio relative to the market, to company competitors or to historic norms, and a low stock price in comparison to assets, earnings, cash flow or other measures. He also looks for situations where new management can increase shareholder value by using excess cash flow to pay down debt, buy back outstanding shares of stock or raise the dividend.
He's been reducing exposure to sectors where he believes risk has risen to uncomfortable levels. In the financial services group, he recently eliminated Citigroup from the portfolio and reduced a position in J.P. Morgan. "The kind of deal activity they're involved with, such as lending to hedge funds and making bridge loans to private equity firms, is not something we are comfortable with," he says.
Financial services stocks that remain in the fund include those with minimal exposure to the mortgage markets and business lines that remain solid. Despite a recent price slide, he continues to own Genworth Financial, a financial services stock he views as unfairly trounced by concerns over subprime mortgage lending woes. He points to it as "probably one of the best examples of a company where the market has thrown the baby out with the bathwater."
Genworth derives only 16% of its earnings from its domestic mortgage business, with the other 84% of its business coming from life insurance, long-term-care insurance and other products that are doing well in the marketplace. Yet the stock's multiple to book value is comparable with that of competitors that are much more heavily involved in the mortgage business. Giroux says it is priced well below fair value, and could rise from a mid-August level of $28 a share to "somewhere in the mid-50s within the next couple of years."
He says U.S. Bancorp has also been punished too severely by the stock market. "The bank has a strong payment-processing business, conservative credit culture and no investment banking activity. Yet it trades at less than 11 times earnings and has an attractive dividend yield of 5.2%."
Recent purchases include Proctor & Gamble. "The stock is trading near its ten-year valuation lows. It's not exciting and it won't blow away earnings, but it has limited downside, good upside, a good franchise and a solid dividend yield." Covidien, a maker of health-care products and a Tyco spinoff, is trading below its peers yet has the potential to realize substantial value by selling its assets and improving its profit margins.
The fund owns a number of stocks, including those in the consumer discretionary and home-building industries, that have been out of favor recently. "I don't think the businesses of the stocks we hold in this category are really discretionary. Cablevision is going to survive because even in the worst recession people aren't going to cancel their subscriptions, and TJX Companies has a strong reputation as an alternative to department stores."
His views on building materials retailers Home Depot and Lowe's Companies reflect the fund's often contrarian stance as well as Giroux's optimism about consumer resilience. He points out that even in a slow housing market, people will move forward with home-remodeling projects, and that both companies have been buying back their stock. He pegs the stocks as "substantially undervalued" and believes that earnings will bottom out in 2007 and begin improving in 2008.
If a company doesn't fit into his parameters for stocks, Giroux may invest in its convertible bond instead. He often uses the strategy for small and midsize companies where stock liquidity may be an issue, or for companies with a higher risk profile that makes purchasing equities a less attractive option. "For some companies, buying the convertible is a good way to get most of the upside from the underlying stock, but more downside protection as well," he says.
Investing in different asset classes and undervalued stocks provides the kind of downside protection and attractive upside profile that his shareholders want, he says. "The people who invest in this fund want one product that diversifies across all asset classes," he says. "They don't want to wake up one day and realize they can't meet their retirement objectives. Too many mutual funds focus on beating a benchmark. But if a fund is down 19% and its benchmark is down 20%, I consider that a big problem."
