March 2017 IssueLong scroll reading

Homestead Growth (HNASX)

By David Snowball

Objective and strategy

The fund seeks long-term capital appreciation by investing, primarily, in domestic large cap growth stocks. The portfolio is diversified (typically 60-75 names) but not sprawling. Direct foreign investment is currently about 5.6%, which is modest but also above-average for its Morningstar peer group.

In general, the fund’s subadvisor T. Rowe Price targets:

  • companies with characteristics that support sustainable double-digit earnings growth and
  • high-quality earnings, strong free cash flow growth, shareholder-oriented management, and rational competitive environments

Their preference is for firms with a lucrative and defensible niche which allows them to sustain their earnings growth even when the economy slows. They’re valuation conscious, and look to buy stocks when there’s a disconnect between long-term prospects and short-term price.

Adviser

RE Advisers of Arlington, Virginia. REA is an extension of the National Rural Electric Cooperative Association, a non-profit that serves America’s rural electric coops. REA was originally chartered to provide investment services for electric coop employees, though their funds are open to all US investors. REA launched in 1990, oversees the eight Homestead mutual funds and has, as of December 31, 2016, $3.4 billion in assets under management.

The Homestead Growth Fund has been sub-advised since 2008 by T. Rowe Price Associates, a famously risk-conscious bunch with over $800 billion in assets.

Manager

Taymour R. Tamaddon. Mr. Tamaddon began phasing-in as manager of the strategy during his predecessor’s last six months at the helm and became the manager in January 2017. Mr. Tamaddon joined T. Rowe Price in 2004 as an equity analyst and became a portfolio manager in 2013. He managed T. Rowe Price Health Sciences (PRHSX) from February 2013-July 2016 when he began to transition to managing this strategy. He succeeded Mr. Sharps at the $13 billion T Rowe Price Institutional Large Cap Growth Fund (TRLGX), which is part of their $30 billion large cap growth equity strategy. Mr. Tamaddon holds a B.S. in applied physics cum laude from Cornell University and an M.B.A. from the Tuck School of Business at Dartmouth University.

Strategy capacity and closure

Exceedingly large and quite unlikely, respectively. The T. Rowe Price large cap growth strategy, of which Homestead is one manifestation, has $30 billion in assets. Steve Kaszynski, president and CEO of the Homestead funds, argues that this strategy invests in “very large, very liquid companies.” Our estimate is that the U.S. large cap universe is valued around $16 trillion. As a result, there’s no immediate capacity constraint imposed by the investable universe.

Active share

  1. “Active share” measures the degree to which a fund’s portfolio differs from the holdings of its benchmark portfolio. High active share indicates management which is providing a portfolio that is substantially different from, and independent of, the index. An active share of zero indicates perfect overlap with the index, 100 indicates perfect independence. HNASX has an active share of 69 which reflects a modest degree of independence from its benchmark Russell 1000 Growth Index. Because HNASX replicates T. Rowe Price’s institutional large cap growth strategy, which has $30 billion in assets, we compared it to the active share of the eight large cap growth funds with at least $25 billion in assets. The average active share for those funds was 68, so HNASX has an active share that is typical of very large, successful large cap growth strategies.

Management’s stake in the fund

None yet reported. I do not anticipate that Mr. Tamaddon, as an employee of T. Rowe Price, will invest in this fund. His predecessor as manager here, Robert Sharps, also did not invest in it though both likely had investments in the corresponding Price product. Similarly only one of the fund’s eight directors has invested in the fund.

Opening date

1/22/2001. For its first seven years, HNASX was managed in-house. On 12/01/2008, the fund became solely managed by T. Rowe Price.

Minimum investment

$500, reduced to $200 for an IRA.

Expense ratio

0.95% on assets of $117 million (expenses and assets as of 12/31/16).

Comments

Do you remember “Two great tastes that taste great together”? It was Reese’s celebration of what happens when milk chocolate and peanut butter intersect. It’s also a slogan they haven’t used in more than a quarter century; the fact that we so easily remember it is a testament to the staying power of a good line.

RE Advisers is on a mission. To understand it, you need to understand a little bit of the history behind it.

Rural electric cooperatives originated in the 1930s when less than 10% of America’s farms had electricity. The result was brutal. If you wanted light, you lit an oil lamp. If you wanted water, you pumped it and hauled it. If you wanted a bit of hot water, you heated it in a bucket over a wood-burning stove. If you wanted clean clothes, you dumped them in a basin with some soap then dragged them back and forth, by hand, over a corrugated metal board, wrung the excess water out by hand and hung them on a line to dry. If you wanted ironed clean clothing, you sat a flatiron on your stove until it was hot (or tossed live coals inside a box iron). It was a miserable existence. While Karl Marx did not decry “the idiocy of rural life” (it’s a widely-quoted mistranslation, the closer translation would have been “the isolation of rural life”), you could certainly be sympathetic to the judgment.

All of that changed with the Rural Electrification Act of 1936 which made federal loans to farmers’ co-ops (rural electric coops) to help them finance the delivery of electric. Within 2 years it helped bring electricity to some 1.5 million farms through 350 rural cooperatives in 45 of the 48 states. Almost half of all farms were wired by the onset of World War Two and virtually all of them by the 1950s.

Much of this work was coordinated by the National Rural Electric Cooperative Association, which still represents 900 rural electric coops. RE Advisors was launched as a tool to help provide “a greater measure of confidence in their financial future” for the folks working at those co-ops. The Homestead Funds, which have unusually low fees for small funds, were one of the tools they used to pursue that mission.  REA manages the funds themselves whenever they have confidence in their in-house abilities; otherwise they negotiate sub-advisory contracts with “best of class” outsiders such as T. Rowe Price. And they offer some of the industry’s lowest purchase requirements: $500 for a regular account and $200 for a tax-advantaged one.

T. Rowe Price is the exact right partner for them. To state the obvious, Price is one of the industry’s most-respected firms. Morningstar’s Katie Reichart described them this way:

T. Rowe Price is an industry leader, with a strong lineup of funds across asset classes. The firm’s disciplined, risk-conscious investment process has consistently produced successful results across its fund lineup, often with less volatility than peers … the firm is in a strong financial position and remains amply resourced. T. Rowe Price has acted in fundholders’ interests by closing funds with surging asset bases and avoiding trendy fund launches. Reasonable fees and a manager compensation plan focused on long-term performance are other pluses. (11/24/2015).

Price’s equity managers average 19 years of experience. As of December, 2016, 86% of T. Rowe Price’s funds had beaten their Lipper peer group average for the past decade. Fortune magazine annually celebrates them as one of “the world’s most admired companies,” most recently ranking them third in their industry. In February 2017, Price’s CEO was invited to join the board overseeing Harvard’s endowment.

Even when Price gets it wrong, they get it right. In 2016, they inadvertently voted “yes” on a proxy vote involving Dell when they’d meant to vote “no.” The mistake cost fund investors $200 million; Price immediately reached out to the boards of the funds involved and promised to make the shareholders whole. Shortly thereafter they wrote the nine-figure check. Barron’s described it as “a booster shot to maintain the firm’s stellar reputation” (6/11/2016).

To recap: Homestead Growth is supported by two exceedingly solid, exceedingly reputable teams. The most important elements for a fund’s long-term success are the clear alignment of the interests of the advisers with the interests of their shareholders and the presence of a talented, disciplined management team. Homestead Growth sports both.

None of which would mean much if the fund didn’t perform well. Happily, it does. Largely under Mr. Sharps’ management, the fund has outperformed its Lipper large-growth peer group for the past one-, three-, five- and ten-year periods, as well as over the course of the current market cycle that begin in October 2007 and the current up-market cycle that began in March 2009. The fund’s annual return over the full market cycle is 170 basis points over its peers. It’s recognized as a Lipper Leader for Total Return and Consistent Returns while Morningstar rates it as a five-star fund overall, as well as a five-star fund for the past five- and ten-year periods. By the Observer’s calculation, the fund has been modestly more volatile than its peers over the past decade but also substantially more rewarding. As a result, its risk-return calculus (reflected in the Sharpe, Sortino and Martin ratios) are all above its Lipper peer group’s.

The question is what to make of the new management that took the helm in January 2017. Four thoughts on that front:

  1. Mr. Tamaddon did exceedingly well at his last charge, T. Rowe Price Health Sciences (PRHSX). Morningstar analyst Robert Goldsborough reports that Mr. Tamaddon “led the fund to a 21.1% annualized gain during the three years ending Feb. 29, 2016. That bested 98% of peers in the healthcare Morningstar Category over that timeframe” (03/24/2016).
  2. Price and Morningstar have both expressed confidence in him. Price just handed him a $13 billion fund within a $30 billion strategy. He’s been with Price for 13 years and performed brilliantly when star manager Kris Jenner resigned from PRHSX. They’ve had time to observe, train and assess him, and he seems to have earned their confidence. Likewise, Morningstar upgraded their analyst rating on T. Rowe Price Institutional Large Cap Growth (TRLGX) from “neutral” to “bronze” in February 2017.
  3. Price handles manager changes well. New managers typically join as part of a long-planned transition and typically work alongside the departing manager for half a year or more. Each manager works with a management committee that includes peer managers and analysts to make sure that they have appropriate support and guidance. On whole, it has worked very well.
  4. Mr. Tamaddon has been doing his due diligence. Homestead’s CEO reports that Mr. Tamaddon visited with the management team for every firm in the portfolio during his six-month transition. Price knows that most top management people have a set “script” they speak from. The key, Mr. Tamaddon says, is “to get the CEO or CFO off script—it gives you a better nuance as to what’s going on.”

The single red-flag is Mr. Tamaddon’s staunch defense of Valeant Pharmaceuticals. He was the stock’s first champion at Price, helped make Price the stock’s third-largest owner and then rigidly defended it as the whole sordid mess came crashing down. As recently as March 2016, just before he left Health Sciences, he wrote that “We have been long-term believers in the company’s business strategy.” By May 2016, Price had liquidated 90% of its Valeant position. By August 2016, Price had filed suit against Valeant, alleging “Defendants’ fraud was so vast in execution and so devastating to investors, patients, physicians and insurers, that media and commentators have dubbed it the ‘Pharmaceutical Enron’.” Mr. Tamaddon was far from the only sophisticated investor taken in by Valeant and Price is not the only major investment firm suing Valeant. Beyond that, he made a whole series of other investments that richly rewarded his investors and his fund’s losses as Valeant imploded were smaller than his average peer’s. It seems unlikely that Price would allow him to repeat the mistake with a huge core portfolio, but it bears keeping in mind.

Bottom Line

Homestead Growth has been, and is apt to remain, an entirely admirable fund, especially for smaller or younger investors who don’t want to tie their fortunes to a passive product. It’s got a very talented management team, a lot of analyst support and an adviser whose mission is shareholder-friendly. The T. Rowe Price version of the fund requires a million dollar initial purchase; here investors can get access to the same skills for just $500. It really should be on more due-diligence lists.

Fund website

Homestead Growth. I’d especially recommend the two short videos that talk about the culture of the NRECA and RE Advisers.

This entry was posted in Funds, Stars in the shadows on by .

About David Snowball

David Snowball, PhD (Massachusetts). Cofounder, lead writer. David is a Professor of Communication Studies at Augustana College, Rock Island, Illinois, a nationally-recognized college of the liberal arts and sciences, founded in 1860. For a quarter century, David competed in academic debate and coached college debate teams to over 1500 individual victories and 50 tournament championships. When he retired from that research-intensive endeavor, his interest turned to researching fund investing and fund communication strategies. He served as the closing moderator of Brill’s Mutual Funds Interactive (a Forbes “Best of the Web” site), was the Senior Fund Analyst at FundAlarm and author of over 120 fund profiles. David lives in Davenport, Iowa, and spends an amazing amount of time ferrying his son, Will, to baseball tryouts, baseball lessons, baseball practices, baseball games … and social gatherings with young ladies who seem unnervingly interested in him.