Emphasizing 'Classical Value' That's Sustainable

Too many mutual funds are bland copies of Standard & Poor's 500-stock index or some other market benchmark. If you're lucky, you'll eke out a small gain over the index, after fees. Most don't even beat their bogey over five- or 10-year stretches.

One cannot accuse the managers of Kinetics Paradigm of hugging any index. This fund is an original. Co-managed by Murray Stahl, Peter Doyle and Paul Mampilly, Kinetics (symbol WWNPX) has returned an annualized 21 percent over the past five years through April 18. That's an average of 10 percentage points per year better than the S&P.

Mampilly calls Kinetics' management style "classical value." The managers are less interested in so-called value stocks that sell at low price-to-book or price-to-earnings ratios than in identifying superior businesses with high and sustainable returns on equity. To Kinetics, a company that sells at a high multiple but with the stamina to sustain 35 percent growth is a value play. "Value and growth is a distinction without a difference," says Mampilly.

Kinetics looks out three to five years when it considers buying a stock. It seeks companies with a sustainable long-term return on equity (a measure of profitability) of 15 percent or more. This draws the managers to stable companies that face little competition and sell products and services with long life cycles. This initial screen, says Mampilly, eliminates most technology companies, which face the risk of obsolescence.

One of the hallmarks of this go-anywhere fund is that once the managers find a company with a compelling business model, they tend to build positions in many businesses in the same industry.

For example, after investing in London Stock Exchange, Kinetics bought shares in stock and futures exchanges around the world. Mampilly says he views these oligopolies as more like utilities or applied technology companies than as financial stocks. Computerization and programmed trading have helped to increase trading volumes vastly around the globe.

Kinetics has also tapped rich lodes in global metal mining companies and oil producers that are involved in Canadian tar sands. Kinetics purchased Suncor (SU), Canadian Natural Resources (CNQ) and seemingly the entire tar-sands industry after calculating that their oil reserves traded at a huge discount to those of integrated oil companies such as Exxon Mobil (XOM).

Kinetics Paradigm charges a steep annual fee of 1.63 percent. As a result, investors should hold this fund to a high standard. Over long periods, Kinetics should produce in excess of 13 percent annualized -- the same 15 percent hurdle rate of its portfolio companies, less the annual management fee.