Fundamentals-based index fund has goods, struggles for attention

BOSTON — Gerald Sullivan’s Industry Leaders Fund boasts Lipper Leader designations, four stars from Morningstar Inc., a solid eight-year-plus track record and an investment process patented by the U.S. government. What it lacks is size. As of last week, the no-load mutual fund, which Mr. Sullivan claims to be the first fundamentally weighted index fund, had just $26 million in assets. “I’m constantly fighting” the size issue, he said, adding that unlike many small funds, his wouldn’t be swamped by a rush of new cash. “The capacity of our product is over $100 billion,” Mr. Sullivan said. But as a no-load from a boutique firm offering no compensation to intermediaries, Industry Leaders (ILFIX) faces a challenge in attracting the attention of advisers, said Tom Roseen, senior research analyst for New York-based Lipper Inc. For simplicity’s sake, he noted, some investors don’t venture from a single fund family with a good brand name. The fund’s track record, however, shows “that by doing a little more legwork and research, we can probably identify funds that are going to help our portfolios out,” Mr. Roseen said.
The fund’s performance has been impressive. Over the eight-year period ended May 31, Industry Leaders beat the Standard &Poor’s 500 stock index by 2.2% a year on average, said Mr. Sullivan, president and chief investment officer of Claremont Investment Partners LLC of Summit N.J. The fund averaged an annualized return of 12.8% for the three-year period ended last Monday, beating the S&P 500 by 0.8 percentage points, according to Chicago-based Morningstar. “I’m confident to say I beat it in the long run, because I have eight years of performance that proves it, and I have 20 years of model results,” said Mr. Sullivan, adding that the fund is “a great complement” to the S&P 500. Stock selection starts with about 1,700 companies representing more than 90 industries in the universe of The Value Line Investment Survey, produced by Value Line Publishing Inc. of New York. Each industry then is screened by book value and balance sheet strength. That typically gets the fund down to 54 or 55 industries. From there, companies are selected based on book value and credit quality. “I look at my portfolio, and I see names and tickers,” Mr. Sullivan said. “I don’t see likes and dislikes.” No company can represent more than 2.25% of the fund. The fund’s investment process was awarded a patent on Sept. 12, 2006, Mr. Sullivan’s 46th birthday. “It was very novel for the patent office,” Mr. Sullivan said, “So novel, that it was hard to explain.” That’s why it surprises Mr. Sullivan when Research Affiliates LLC chairman Robert Arnott, whose methodology debuted in 2004, often is credited with pioneering fundamentally based indexes. Pasadena, Calif.-based Research Affiliates’ fundamental-indexing methodology is used in managing more than $9 billion in assets worldwide. Mr. Sullivan initially decided not to promote the fund until it had a five-year track record. He then postponed promotion until he received a patent. Checking the model “We didn’t want to come out Day One and tout a track record,” Mr. Sullivan said, adding that he has seen firms put back-testing data on the same page as their exchange traded funds. “We wanted to keep everything separate,” he said. “We wanted to make sure that the model worked.” The fund’s performance seems to be attracting attention. Mr. Roseen of Lipper noticed the fund this month when screening for funds for a podcast on Lipper’s website. Industry Leaders scored highly in three categories — total return, consistent return and preservation of capital. The only Lipper Leader category where it failed to make the cut was in tax efficiency. “It was one of the funds that were off the radar,” Mr. Roseen said, adding that “off the radar does not mean that they weren’t performing.” The fund was one of just three large-cap-core funds — MFS Union Standard Equity Fund (MUEAX) and TS&W Equity Portfolio (TSWEX) are the others — that ranked as Lipper Leaders in all three categories in each of the prior 12 months on a rolling three-year basis. And Industry Leaders’ Hurst exponent, a volatility measure, showed that it offered investors the smoothest ride of the three, Mr. Roseen said. Even assets have been growing. Industry Leaders has more than doubled in size since April 2006, when it had $12 million in assets, Mr. Sullivan said. “It’s been a long and interesting ride, and it’s getting more fun,” he said.