This Top Mutual Fund's Surprising Appetite For Leading Stocks

With a portfolio featuring leading stocks like Amazon (AMZN), Charles Schwab (SCHW), E-Trade Financial (ETFC) and UnitedHealth Group (UNH) as of Dec. 31, $1.9 billion USAA Growth & Income Fund (USGRX) is going strong after having outperformed both its Morningstar large-cap blend category and the S&P 500 in four of the six most recent full quarters.

Its 0.79% gain so far this year going into Thursday — after the market’s recent volatility — is also ahead of the big-cap bogey and its peer group.

X The fund owes its portfolio firepower to a double-barreled management approach. The fund is run by two groups of managers, who work independently of each other. That doubles their opportunities to generate investment ideas. One group consists of subadvisors Barrow, Hanley, Mewhinney & Strauss, who focus on value-oriented stocks for the fund. The second team works for USAA Asset Management, and they focus on growth stocks.

“Using two managers with different approaches can potentially provide more consistent returns over the long term,” said USAA’s Wasif Latif, who oversees the teams running the two sleeves.

Currently, Barrow Hanley runs about 40% of fund assets, with the balance run by the USAA team. Parent firm USAA maintains that ratio by allocating new inflows.

Although the Barrow Hanley team’s mandate is to focus on value stocks, their portfolio sleeve still includes leaders like E-Trade and UnitedHealth, which happen to have several traits of top-notch growth names, such as IBD Composite Ratings of 99 and 94 as well as SMR Ratings of A and B respectively.

Amazon and Schwab are in the fund’s growth sleeve. Amazon sports a red-hot 99% three-year annual earnings per share growth rate. Its three-year sales growth rate is 26%.


IBD’S TAKE: Keep up with news and analysis of Amazon at IBD’s web page devoted to the e-commerce and cloud-computing colossus.


Schwab’s three-year annual EPS growth rate is 22%. Its EPS is expected to grow 45% this year.

And if ups and downs in the stock market today presage additional volatility in the near term, the fund’s blended approach should serve it well, says Mark Giambrone, head of the Barrow Hanley team. The value sleeve has “traditionally outperformed (the overall market) during weaker periods in the market,” Giambrone said.

Still, Giambrone blames recent market volatility on program-trading by index funds. Fundamentals are still sound, in his view. “We have a positive economic backdrop for corporate earnings and cash flows and consumer confidence and spending,” he said.

E-Trade shares are up 46% in the past 12 months. Giambrone’s sleeve has owned E-Trade for several years. As a value investor, he seeks to buy stocks when temporary ills have dropped their share prices. He bought his current E-Trade stake when it was trading below book value due to investors’ concerns about its portfolio of home-equity loans, he says.

Those loan woes have been cleared up, he says. “They’re garnering market share,” he said. “They’re benefiting from rising rates (which allows its net interest margin to expand on clients’ cash in its custody). And we expect consolidation among online brokerage firms.”

Dow Jones industrial giant UnitedHealth is the Giambrone sleeve’s largest nonbank position. He sees the firm as a health care technology and services provider. Half of its earnings, he says, come from its Optum unit, which provides pharmacy benefits management and technology services and also runs clinics and doctors’ offices.

Optum’s data cache enables UnitedHealth to lower its own costs and its charges to customers. “Optum is an incredible growth engine and differentiator for UNH,” Giambrone said. “It helps current healthcare clients and non-healthcare clients lower cost trends through technological advances. It is a key driver of the investment thesis.”

Overall, UnitedHealth has great cash flow and a reasonable valuation. “It’s mostly a U.S. business, so it’s helped by recent tax law changes, which can help raise its earnings,” Giambrone said.

Giambrone also likes Royal Caribbean Cruises (RCL). Shares in the multi-cruiseline operator are up about 35% in the past 12 months.

Royal Caribbean should benefit from expansion of destinations and markets in China and Cuba, Giambrone says. At the same time, industrywide supply of ships shows only modest growth. Giambrone says earnings should grow for years.

He added, “The company has not benefited from tax reform. But once the market settles and focuses on long-term benefits (of tax reform) rather than short-term reform, the company will benefit meaningfully.”

Giambrone says regional bank KeyCorp (KEY) benefits from healthy loan growth. “Credit (risk) is fairly stable, and tax reform will have a big positive impact on the bank,” he added. KeyCorp’s 2016 acquisition of First Niagara should provide economies of scale, he says.

He added, “We think the regulatory environment should get better for banks. The ‘SIFIs’ threshold may rise to $250 billion, which would make it easier for them to expand.”

SIFIs threshold refers to the asset level at which banks are deemed systemically important financial institutions, triggering much stricter oversight, including higher capital buffers.

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