Sector Favorites from a Large-Cap Manager

02/02/2012 6:30 am EST

Focus: FUNDS

S&P 500 components weighted toward sector strength is the focus of the Institutional Advisors LargeCap Fund (IALFX), run by Terry Morris. He discusses why he currently likes consumer stocks, along with healthcare, technology, and industrials.

Kate Stalter: I’m speaking today with Terry Morris. He’s the manager of the Institutional Advisors LargeCap Fund, and that’s been around a little less than three years.

Terry, you’ve been manager of this fund since its inception. Tell us a little bit about your fund’s philosophy. What are some of your objectives?

Terry Morris: Well, we’re core equity managers, Kate, meaning we employ both growth strategies and value strategies. So our style is not growth or value. It’s both.

We believe that by trying to find companies that possess both growth and value characteristics, we are more likely to be consistent, relative to the overall market at any given time. And it’s very much an approach whereby we try to own companies with high profitability, high growth in that profitability, and yet profitability that’s very consistent and reliable…all at the same time selling at good valuations.

And then we take a look at the best of those kind of companies, relative to the overall market, relative to the sector that they reside in, and relative to the subsector that they reside in, and try to pick the best businesses and then look at those companies that score well, and then try to see how they have done, relative to the overall market. That is, how the stock itself has done, not the business.

So, we try to own great businesses and stocks, because they’re not always the same, and we try to be patient. We’re not traders. We’re investors, so our turnover is relatively low. We hold on and we try to make judgments as to what sectors to be overweight and underweight.

As an example, last year we were fortunate enough to be underweight financials all year, and that turned out to be the worst-performing sector, so that helped us. Sometimes it’s not so much what you own as it is what you don’t own, when it comes to comparing yourself to an index.

We were fortunate in that way, in the sense we were also overweight consumer staples and overweight health care, which were some of the better performing sectors for 2011.

Kate Stalter: I was looking at some data for the funds, Terry, in terms of some of the performance. I do notice that you have been outperforming the benchmark index.

One thing I was curious about: According to Morningstar, you’re very heavily invested in US stocks. Is that still the case?

Terry Morris: Yeah, the fund, Kate, is benchmarked to the S&P 500, so that’s our bogey. In fact, we limit our purchases to stocks within the S&P 500, and although they have a global footprint, they are all domestic companies.

We really don’t have any international expertise, so it is purely a domestic fund, although we have the Exxons (XOM) of the world and so forth, that have, as I said, worldwide presence. But they are based here.

Kate Stalter: You were talking a moment ago about some of the sector weightings, and I appreciate what you were saying about being out of financials last year. That seems like it must have been a big deal.

But you mentioned, for example, consumer cyclical. I also noticed you had some holdings in tech. Can you say something about the sectors you like right now?

Terry Morris: Yeah, because we are trying to own high profitability and high consistency, or high stability of earnings growth, we tend to favor the more reliable and less cyclical sectors, and that would lead you toward consumer staples and health care. So we are and have been overweight in that sector.

Our biggest position is in technology. However, technology is also the biggest position in the S&P 500. Tech represents almost 20% of the index. We’re at about 23% as of yesterday. So, we are modestly overweight tech, but consumer staples are around 11% of the index. We’re at a little over 14%. Health care is around 11.5% of the index. We’re around 16.5%.

We also make sure that we’re in at least seven of the ten sectors, so that our clients are diversified that way, and so that we are making sure we’re not making too big of bets on any one sector, in case we happen to hit a bad time for that sector.

Kate Stalter: Anything in terms of sector rotation that might be on your radar at the moment, where you’re seeing either something falling out of favor, or something that might be coming into favor in the next few months?

Terry Morris: I guess the best momentum right now seems to be coming out of the industrial area, the industrials sector.

The financials we’re still underweight and would be inclined to stay underweight. The stocks have moved up nicely over the last couple of months, but I think that’s in part a January effect, because of it being the worst-performing sector last year.

I think there is often a bounce in January of the sectors that did the worst the prior year. The financials, at this point, I believe have gone up more than the fundamentals, so we remain underweight in that area.

I would say that the area that’s improved the most from a fundamental standpoint, while the stocks have sort of underperformed the fundamentals and therefore they look attractive, I would say is probably the industrials sector.

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