Saturday, May 11, 2013

Capital Opportunity: Low-cost growth

Mark SalzingerVanguard reopened its Capital Opportunity Fund (VHCOX) in April. This is good news for Vanguard investors seeking an aggressive, low cost, actively managed growth fund.

Capital Opportunity had been closed for about nine years. It now becomes the only PRIMECAP advised fund at Vanguard to be open to new investors.

Capital Opportunity has had an especially good year so far. Through April, the fund was up 19.1%. Over the past 12 months, the fund's gain of 29.4% was among the very best of all the funds we track.

Long-term performance has also been excellent: 12.2% annualized over the past 10 years, for example, versus 8.1% for the S&P 500.

Nevertheless, the fund has lagged at times, even for as long as a couple of years. Case in point: in 2010, the fund's gain of 11.1% trailed the S&P 500 by four percentage points, while its 6.2% loss in 2011 stung next to the index's 2% gain.

PRIMECAP Management has a long-term investment perspective, so PRIMECAP managed funds tend to keep holdings for many years. In fact, the portfolio turnover ratio of Capital Opportunity has averaged about 10% annually over the past decade, perhaps the lowest we've seen with an actively managed fund.

This benefits the funds when the holdings are in strong, multiyear uptrends. However, it can hurt during the inevitable periods when such holdings pause for breath, or even fall due to lofty valuations on current earnings or simply to changes in investor tastes.

Also, the funds are undiversified by sector. PRIMECAP Management goes wherever it sees the best long-term values among stocks with multiyear growth opportunities. So, they may be very 'overweight' in certain sectors of the market, while having virtually nothing in many other sectors.

Historically, the broad information technology and healthcare sectors have accounted for the majority of the assets of Capital Opportunity. Today, this positioning is even more pronounced, with these sectors accounting for 34% and 39%, respectively, of assets.

Within information technology, several industries are represented, including Internet search (e.g., Google), network security (e.g., Symantec), semiconductors (e.g., Texas Instruments), software (e.g., Microsoft and Adobe) and data storage (e.g., EMC).

If there are common threads among the information technology holdings, it's that they have decent to excellent opportunities for long-term growth, along with large cash holdings on their balance sheets and fairly low valuations.

In healthcare, the managers include significant exposures to large pharmaceutical companies (e.g., Roche and Novartis), biotechnology firms (e.g., Amgen) and medical device makers (e.g., Medtronic), but also to various companies engaged in using the human genome to develop targeted treatments.

Capital Opportunity has nothing (or close to it) in consumer staples, energy, financial services, telecommunication services and utilities, and very little in cyclical stocks generally.

PRIMECAP Management stresses individual decision making. Instead of one manager or one team running the fund, PRIMECAP employs a multiple counselor system, in which each fund's assets are divided among four or five senior portfolio managers.

Capital Opportunity recently included about 120 stocks, the top 10 of which accounted for 38% of assets as of March 31. Foreign holdings (mainly large foreign pharmaceutical companies) accounted for less than 15% of assets.

The fund's expense ratio of 0.48% is minuscule for an actively managed stock fund; combined with the fund's low turnover and strong tax efficiency, this makes it one of the most efficient funds around.

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