David R. Fassnacht, manager of the $21 billion Vanguard Windsor Fund, is looking in unlikely places for undervalued stocks to improve his performance.
Fassnacht, who took over the Windsor fund in July from Charles T. Freeman, is buying shares of computer-related companies such as Cisco Systems Inc. and drugmakers including GlaxoSmithKline PLC, two industries better known for having above-average earnings growth than for having cheap stocks.
Under Freeman and previous manager John Neff, Windsor was known for buying stocks considered cheap relative to profits and other financial yardsticks. Neff was involved in managing the fund for more than 30 years, until 1995, and helped establish -- along with Freeman -- one of the best long-term investment records in the $7.9 trillion mutual fund industry.
"We're there to buy the best, most attractively valued stocks, regardless of where they might be," said Fassnacht, 39, in an interview from his office in Radnor, Pa. There are "more opportunities in names that historically have fallen under the growth banner," he said.
Vanguard Windsor, which has focused on so-called value stocks throughout its 46-year history, rose 13 percent during the past 12 months, placing 17th of 44 U.S. stock mutual funds with more than $10 billion of assets, data compiled by Bloomberg show. The top-performing fund in the group was the $11.4 billion Fidelity Value Fund, up 21 percent.
Fassnacht has purchased shares of Applied Materials Inc., the largest producer of equipment used to make computer chips, as well as Cisco, the world's No. 1 maker of computer-networking equipment. His holdings also include two of Europe's largest drug companies, GlaxoSmithKline and Sanofi-Aventis SA.
Shares of so-called growth companies, those expected to record the biggest earnings gains, are cheaper than they were when equity markets peaked in 2000. The average stock in the Russell 1000 Growth Index trades at 24 times earnings, compared with 51 times in 2000, Bloomberg data show.
"We're hearing from a lot of value-oriented managers that they're taking this opportunity to move into stocks with growth prospects," said Christine Benz, an analyst at Morningstar Inc., the industry research firm in Chicago. "My goodness, Cisco is in the portfolio right now, which isn't something that Windsor shareholders might be expecting."
"Traditional growth industries, areas that we might not have looked at five or six years ago because of their valuations, are coming into levels that we think make sense," said Katrina Mead, manager of the $7.4 billion MFS Value Fund, on a June 20 conference call. That group includes pharmaceuticals and specialty retailers, she said.
Vanguard, the biggest U.S. stock and bond fund company, uses three firms to manage Windsor. Fassnacht's seven-member group at Boston-based Wellington Management Co. oversees 70 percent of the fund. The Sanford C. Bernstein part of New York-based Alliance Capital Management Holding LP runs 28 percent, and Vanguard's in-house managers oversee the cash portion.
Fassnacht, a graduate of the University of Pennsylvania's Wharton School, started his investment career in 1988 and joined Wellington three years later. He worked for Neff and became a co-manager under Freeman, who started running Windsor in 1996.
Fassnacht and his team calculate the value of a stock based on their estimate of a company's average earnings over five years. They also evaluate a company's dividend payments, cash flow, management quality and competitive position. They buy stocks with the goal of gaining at least 30 percent in two years.
The manager purchased shares of Santa Clara, Calif.-based Applied Materials last summer when the "semiconductor industry was in a freefall," he said. The company's shares have gained 6.3 percent since the end of August and closed Friday at $16.45.
Applied Materials' stock sold at less than market price when taking into account its $4 a share in cash, Fassnacht said. The stock should grow "at a pace that's a little bit better than the market," he said. "That was attractive math for us."
Fassnacht purchased shares of San Jose-based Cisco after the stock fell in four of the past five years. The stock ended the week at $19.30 a share. The company's price-to-earnings ratio is 23, compared with the 33 multiple of the Standard & Poor's 500 Communications Equipment Index.
When investors react negatively to short-term news, "it usually creates an opportunity for us to be patient and add to our position at attractive prices," he said. Conversely, "when a stock gets to fair value, people are excited and enthusiastic and buying into the idea and usually it creates an opportunity to get out of the position."
The manager said he bought shares of London-based Glaxo and Paris-based Sanofi-Aventis when they were selling at 11 to 13 times earnings and the market average was 16. Other investors may have overlooked, or been too impatient to wait for, early-stage drug development that could lift the stocks within 18 months, he said.
"Our view was we were getting stocks really cheap at great yields and getting paid to wait," Fassnacht said.
Shares of Glaxo, maker of the diabetes medicine Avandia, have gained 27 percent since July 1 and closed Friday at $49.25. Sanofi-Aventis has risen 31 percent and ended the week at $41.12 a share.
Windsor has outpaced about two-thirds of the funds with similar investment objectives during the past five years, as it rose at an annual pace of 8.6 percent, Bloomberg data show.
"This isn't a fund you want to judge by short-term time periods," Morningstar's Benz said. "It will be streaky, and management will be early into some of these unloved stocks."