Thomas J. Digenan, manager of the UBS U.S. Large Cap Equity Fund, says he is avoiding most energy stocks because he expects oil prices to fall. His contrarian investments have led to one of the best three-year performances in the mutual fund industry.
"We really believe that if you focus on valuation, you're going to get it right," Digenan said in an interview from his office in Chicago.
The money manager said he is buying shares of banks such as J.P. Morgan Chase & Co., undeterred by concern that eight interest rate increases by the Federal Reserve may depress banking industry profits. Digenan held just a few energy stocks, including Exxon Mobil Corp., as oil prices almost doubled in the past two years.
UBS's $210 million fund rose at an average annual rate of 6.3 percent during the past three years. Of 40 competing funds tracked by Bloomberg that concentrate assets in companies with market values of more than $10 billion, only the Goldman Sachs Growth & Income Fund has risen more. By contrast, the benchmark Standard & Poor's 500-stock index advanced at an annual pace of 4.4 percent in the three-year period.
Digenan, 41, has had about 3 percent of his fund's assets invested in shares of energy companies. Most of his competitors have about four times as much money devoted to the sector. The money manager's bearish stance is based on his forecast that oil prices will fall as much as 50 percent, to $25 to $30 a barrel, because he said demand for oil is abnormally high.
"We have a pretty good degree of confidence that oil is going to move toward fair value," Digenan said.
Digenan and co-managers John C. Leonard, 45, and Thomas M. Cole, 43, have largely steered clear of energy stocks for more than a year. The fund's largest energy holding is Irving, Tex.-based Exxon Mobil, which the UBS fund has owned for two years.
Exxon Mobil, which closed Friday at $57.60, represents 2.7 percent of the fund's assets. By contrast, the Goldman fund has 11 percent of its $1.2 billion in oil and gas stocks.
Digenan said he has hung on to shares of Exxon Mobil because he thinks they're fairly valued. The stock trades at 13.3 times what analysts expect the company to earn this year, compared with an average 19.3 for companies in the S&P 500.
Oil stocks climbed 36 percent in the past year, buoyed by optimism about demand for crude from the United States and emerging economies such as those of China and India. The S&P 500 rose 6.9 percent in the same period.
Digenan and his colleagues don't mind being out of step with market trends, said Arijit Dutta, an analyst at Chicago-based research firm Morningstar Inc. "When a sector goes down, that's when they pounce and look for opportunities," he said.
UBS's fund added to its holdings in banks, including J.P. Morgan Chase, the second-largest U.S. lender by assets, in the first quarter, as analysts questioned the company's prospects with rising rates and falling stock markets.
The fund's biggest investment is Citigroup Inc., J.P. Morgan Chase's larger competitor. Top 10 holdings also include Morgan Stanley & Co., the world's largest securities firm, and Wells Fargo & Co., a U.S. bank that had record earnings in the first quarter.
J.P. Morgan Chase had record first-quarter profit, as investment-banking profit surged 30 percent, to $1.33 billion. Excluding merger and legal settlement costs, the bank earned 81 cents a share, beating analysts' average estimate of 69 cents.
The company's stock has fallen 7.5 percent this year, contributing to the UBS fund's 2.5 percent decline. J.P. Morgan Chase rose 6.2 percent last year after soaring 53 percent in 2003. The stock ended the week at $35.61 a share.
Digenan has co-managed the fund since 2001 alongside Leonard, UBS's deputy global head of equities, and Cole, head of research for North American core equities.
The managers dissuade their 30 analysts from paying attention to short-term measures of a stock's value, such as comparing price to earnings, Digenan said. The team examines industry trends, analyzes competitors and looks at individual companies' future earnings prospects to determine "if we were a cash buyer for the business, how much would we pay for it?" he said.
"You can mix up the noise with information, and we want to stay away from that," Digenan said. The fund holds 65 stocks.
Digenan earned a bachelor's degree from Marquette University in Milwaukee and a master's in taxation from DePaul University in Chicago. A certified public accountant, he worked for KPMG Peat Marwick before joining the firm now known as UBS Global Asset Management in 1993. The company's parent, UBS AG, is based in Zurich.
Digenan and his colleagues added to their stake in Albertson's Inc., the second-largest U.S. supermarket chain, after the company last month said 2005 profit would be less than analysts were estimating. Albertson's, of Boise, Idaho, has the eighth-worst analyst rating in the S&P 500, according to data compiled by Bloomberg. Shares of Albertson's are down 16 percent this year and closed Friday at $20.01.
The 2,500-store chain has been gaining market share faster than rivals since a 4 1/2 -month strike in California ended in early 2004, Digenan said.
The fund has avoided most big pharmaceutical companies because of concerns about product development, expiring patents and a possible drop in drug prices with the introduction of the Medicare prescription-drug program next year, he said.
It does own shares of Allergan Inc., maker of the anti-wrinkle treatment Botox, which Digenan said provides good long-term prospects because of its new-drug pipeline. The Irvine, Calif., company said pharmaceutical sales would be as much as $2.2 billion this year, with about $840 million coming from sales of Botox.
As baby boomers age, "the one area [where] you do not have pricing pressure is in these vanity-type drugs that people are willing to pay for," Digenan said. Allergan shares ended the week at $74.08.
