A mutual fund that succeeds by taking the emotion out of investing

  • By Sarah Max,
  • Barron's
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Most mutual-fund investors understand the danger of style drift—when a manager inexplicably veers from his or her strategy. It can detract from long-term returns and wreak havoc on an overall portfolio.

In a similar vein, co-managers Chuck Severson and Ken Hemauer take issue when a holding in their $2.1 billion Baird MidCap fund (BMDSX) shows signs of thesis drift.

“Over time businesses can change, but if, for example, we invest in a company because of its strong organic growth and one day wake up and hear it made a risky acquisition, we’ll move on,” says Severson, 58.

That happened five years ago, when one of the fund’s holdings at the time, Dollar Tree (DLTR), unexpectedly announced it was acquiring Family Dollar. The morning the news broke, Severson was already at his desk when Hemauer walked by and, without missing a beat, told him: “I know, we’re selling Dollar Tree.”

In hindsight, it was the right decision, considering Dollar Tree’s tricky transition—it is now closing hundreds of Family Dollar locations. More important, it speaks to how the Milwaukee-based managers stay on the same page and, in the process, deliver consistent returns.

Over the past decade, the fund has returned an average of 16.2% a year, better than nearly 70% of mid-cap growth funds—and with less volatility. The fund tends to beat its benchmark in a rising market and lose less in a down market.

Both Severson and Hemauer learned the rigors of fundamental research in the Applied Security Analysis program at the Wisconsin School of Business in Madison. After graduation, Severson began his 30-year career at Baird, where he helped launch the firm’s mid-cap growth strategy in 1993 and in late 2000 rolled it out as a mutual fund. A year later, he hired fellow UW alumnus Hemauer as an analyst covering financials and in 2010 promoted him to co-manager. The team is rounded out by four senior analysts covering cyclicals, health care, consumer, and technology.

While the fund has always focused on owning high-quality companies with the potential to grow earnings year after year, the managers put tighter parameters around their process in 2006. They instituted a written report that outlines the investment thesis based on five key criteria: profitability, revenue growth, industry outlook, management quality, and expectations for the stock. That “Prime” process, as they call it, grounds all of their investment decisions.

“We wanted to take the emotion out of decision-making by putting our investment thesis on paper so we can go back to it when the bullets are flying in the market,” says Hemauer, 51.

An idea also needs to fit in with the rest of the portfolio. The managers keep the fund’s sector weightings within 75% to 125% of its benchmark, the Russell Midcap Growth index, but with just 50 to 60 holdings. “The individual slots within the portfolio are really valuable,” Hemauer adds.

Recently, the largest slot went to Euronet Worldwide (EEFT), a holding since 2015 that is part of the booming payments industry, but “uniquely so,” according to Hemauer. CEO Michael Brown co-founded the company in 1994 after observing there weren’t a lot of ATMs in Eastern European countries relative to other developed countries. Euronet—which is actually based in Kansas—keeps growing its ATM business in overseas markets. “They are very efficient at identifying where people are moving, where they’re vacationing, where they’re transacting, and they’ve built a network of 40,000 ATMs,” Hemauer says.

Meanwhile, Euronet has parlayed that expertise into a thriving money-transfer business in U.S. markets. Hemauer thinks the company can continue to post double-digit revenue growth. At 24 times 2019 earnings, the stock trades at a discount to many of its payments peers, and could command a higher multiple as the market realizes there is more to its growth story than cash machines.

The market also assumes that e-commerce is the death knell for distributors, but specialized wholesalers still have a role. Consider wholesale computer distributor CDW (CDW), a fund holding that sells computers and technology services to small- and medium-size companies, government organizations, health-care firms, and educational clients. Roughly 60% of its revenue is recurring, says Severson, and the company has consistently grown revenue at a faster clip than information-technology spending overall.

“We like these leading distributors because they are kind of the arms dealers of their industries,” says Severson. “You don’t have to pick who’s got the best product right now because that can change very quickly.”

Yet these companies are the first line of defense for their customers, who count on them to keep things running smoothly in their businesses—and their backyards.

Another top holding, Pool Corp. (POOL), is the world’s largest distributor of pool supplies and the dominant player in U.S. markets. The fund first bought the stock in 2016 and increased its position in 2017, when shares sunk about 20% to less than $100, over concerns Amazon.com (AMZN) was jumping into the pool business.

The stock has since buoyed to $191 as investors realized Pool Corp. is a formidable competitor in its niche, thanks to its size, deep ties with contractors, and the nature of its business. “If you’re a pool owner and your pump breaks in the middle of the summer, you’re going to do what you need to get it fixed,” says Severson, noting that more than half of sales are for maintenance and repairs.

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