Fund focuses on precise value

In times like these, when the equity markets swing wildly and just about everything can look cheap from certain angles, the focus on value has to be especially precise. That's the case being made by Henry Sanders III, one of three portfolio managers responsible for the $60 million Aston/River Road Dynamic Equity Income Fund (ARDEX), offered by Chicago-based Aston Asset Management LLC. Other managers involved with the fund are James Shircliff and Thomas Forsha. The fund is subadvised by River Road Asset Management LLC, a Louisville, Ky., firm whose entire $3 billion in assets is managed under the absolute value umbrella. As Mr. Sanders explained, absolute value is positioned between deep value and relative value. "With deep value, we risk falling into value traps by investing in companies that might never recover, and with relative value you can get caught up in momentum investing," he said. "The absolute value strategy considers the fair market value of a company, and although we will make allowances for current market conditions, we don't want to get caught up in any momentum." This particular all-cap equity strategy was first rolled out to institutional-class investors in October 2003, and was introduced in the form of a mutual fund in June 2005. Although relatively straightforward, the fund is unique enough that it doesn't fit into a typical style box. Morningstar Inc. of Chicago, which has given the fund a five-star rating, has placed it in the mid-cap value group despite the fact the portfolio will hold companies with market capitalizations ranging from $500 million to more than $10 billion. This year through Thursday, the fund was down 8.3%, compared with an average decline of 13.1% for the Morningstar mid-cap-value category. Over the 30 days through Thursday, the fund was down 0.6%, while the category was down 3.8%. A foundation of the strategy is dividend income. The portfolio is separated into three broad groups to reflect its emphasis on dividends. The core group is made up mostly of large-cap companies like Fairfield, Conn.-based General Electric Co. (GE), Charlotte, N.C.-based Bank of America Corp. (BAC) and Minneapolis-based U.S. Bancorp (USB). These are all examples of companies that have shown a history of being committed to paying healthy dividends. The dividend yield of General Electric is around 5%, Bank of America pays 8.7% and U.S. Bancorp is at 4.8%. The second category is the high-alpha group, which is made up mostly of smaller and midsize companies. Mr. Sanders described the companies in this group as being "faster growth stocks" with an average dividend yield of 3.6%. An example is Lebanon, Tenn.-based CBRL Group Inc. (CBRL), the operator of Cracker Barrel restaurants. The stock closed Friday at $26.95, down 15% since the start of the year. The Standard & Poor's 500 Index had declined 17.4% over the same period. The final category, the high-yield group, is also made up of smaller companies, but with a higher average yield and slower average growth, according to Mr. Sanders. The average dividend yield of the stocks in this category is 5%. Two examples of stocks in this group are Fort Worth, Texas-based Encore Energy Partners LP (ENP) and Tulsa, Okla.-based Magellan Midstream Partners LP (MMP). Encore's dividend yield is 8.2% and Magellan's is 14%. Both of the energy-related companies are structured as master limited partnerships, which means that, similar to real estate investment trusts, they pass most of the income on to shareholders. While the portfolio research is primarily characterized as bottom up, it does employ a general screen to narrow the overall market down to about 1,000 names by concentrating on higher dividend yields and adequate liquidity. "The companies that really look interesting to us go into the security analysis phase," Mr. Sanders said. This six-step process begins by considering companies with a high and growing dividend yield. It is the most important criteria, according to Mr. Sanders. Beyond that, the analysis considers a company's general financial strength, whether it is priced at a discount to the research team's absolute value estimate, the attractiveness of the business model, shareholder-oriented management and whether it is undiscovered by the market. In addition to being undiscovered, Mr. Sanders said, companies can meet these criteria due to various market forces, such as those currently hitting the financial services industry. "Some companies are underfollowed or misunderstood," he said. Questions? Observations? Stock Tips? E-mail Jeff Benjamin at jbenjamin@investmentnews.com.