Not all growth mutual funds take a bite of Apple
BOSTON ó A mutual fund manager usually can count on having a good year if the largest investment in the portfolio is surging. But thatís not the case for Tony Trzcinka.
The largest holding in his Pax World Growth Fund is Apple Inc., and shares of the technology icon are up 44 percent. Thatís four times more than the broader market. Yet Trzcinka is being questioned about the fundís 12.5 percent return. Although thatís a strong result just four months into the year, it trails more than 80 percent of the fundís large-cap growth stock peers.
ďItís related to one stock: Apple,Ē says Trzcinka, whose strong long-term record has earned the fund a 4-star rating from Morningstar.
Stock of the worldís most valuable company recently made up 2.5 percent of the fund. Itís not an unusually large position, but itís the fundís biggest single holding, slightly more than second and third-largest ones, Google and Qualcomm.
Apple shares are so valuable that they make up nearly 7 percent of a growth-stock index that Pax World Growth (PXWGX) uses as a benchmark. So Trzcinka would need to nearly triple the fundís stake in Apple to align with the index.
With its enormous weighting in the market and strong recent gains, Apple is having a huge impact on performance of large-cap growth funds this year. With a few exceptions, those owning a lot of Apple are beating a majority of their peers. Most large-growth funds that own relatively little Apple are lagging.
One example: Nearly 18 percent of the Matthew 25 fund (MXXVX) was recently invested in Apple, and the fundís 23 percent return this year is in the top 1 percent among large-cap growth funds.
Appleís importance to large-growth mutual funds has become so great that managers face a crucial question. For most, itís a matter of how much Apple to own, not whether to own it or not.
More than 84 percent of large-growth funds own Apple, according to a recent Morningstar analysis.
Even funds that normally wouldnít invest in a growth-oriented stock like Apple are getting in. Morningstar found that one of every five value-oriented funds owns Apple.
The case for Apple is easy to see. The company reported selling 35 million iPhones in the first quarter, almost twice as many as a year ago. Its earnings were $11.6 billion, nearly double the year-ago total, and revenue jumped 59 percent. Apple beat analystsí expectations on both key performance measures.
Yet there are large-growth fund managers like Trzcinka who continue to argue that Apple isnít necessarily a great investment. He says Apple has top products, but believes long-term prospects arenít as good as the stockís price implies.
ďIts revenue projections assume that every new product introduction will be a hit,Ē Trzcinka says. ďThis is especially worrisome given Appleís short product cycle.Ē
He also says there seems to be little attention paid to the possibility of competition taking market share or cutting into margins.
The latter scenario is a key reason why Aziz Hamzaogullari hasnít bought any Apple stock in the two years heís run the Loomis Sayles Growth Fund (LGRRX). The stockís absence is one reason that the fund trails 90 percent of its large-growth peers this year, even with an 11.7 percent return.
Hamzaogullari acknowledges Appleís strengths, but says itís not a good fit in a portfolio that heís managing for long-term results. He tends to hold stocks for several years.
Consumer products companies tend to attract more competition than firms making products for corporate or government clients, he notes. And he sees the competition heating up for Apple, which could erode its profit margin and market share. The iPhone already faces a threat from mobile phone companies that are promoting cheaper phones running Googleís Android software.
Hamzaogullari says itís worth remembering the difficulties that two of Appleís rivals have faced in recent years. In the past decade, Nokia and BlackBerry maker Research in Motion both had a sizeable share of the mobile device market and strong growth prospects.
The iPhone generates about half of Appleís profits, but Hamzaogullari says that will be hard to maintain.
One reason the phones are such hot sellers in the U.S. is that mobile providers typically subsidize the cost, and make back their expense through monthly service fees over the life of a customerís contract. Itís a model that has worked for Apple and the providers that sell iPhones in the U.S. and some developed countries.
But Apple could have a tough time expanding into more populous emerging markets because prepaid mobile service plans are common there. Those plans typically require consumers to pay the full price of a phone upfront. Hamzaogullari believes Apple will have less success selling its premium smartphones in developing countries where consumers live on more modest means.
So heís comfortable being an Apple holdout, even if its absence from his fundís portfolio may hurt short-term results.
When selecting investments, Hamzaogullari says heís not considering what his fundís peers are investing in. Instead, he considers whether a stock might perform well over a minimum of five years or longer.
With Apple, he says, ďIn the end, we believe that its margins, market share and the business model are not sustainable.Ē