Equity Exposure

Is anybody out there still standing? Keith Hembre and David Chalupnik, co-managers of the Strategy Aggressive Growth Allocation Fund at FAF Advisors, Inc., in Minneapolis still are. They offer one of four “lifecycle funds” for different risk appetites through the First American Fund family. They’ve managed to zigzag their way through some particularly rocky shoals that have grounded even the most well-diversified portfolios of stocks, bonds, and cash.

Hembre heads asset allocation for FAF’s lifecycle family, which are funds made up of other FAF funds. Chal-upnik manages the equity portion of the $145 million offering. With markets worldwide reeling from subprime mortgage woes, U.S. consumers diving into the foxholes, and credit seizing up just about everywhere, Hembre and Chalupnik have made the best of a bad situation.

{Q} How have you weathered the storm: the downdraft in the markets and a decent rally in the bond market—an odd situation given your modest weighting in bonds?

{HEMBRE} The fund’s strategic allocation for long-term buy-and-hold [securities] is 90 percent equities, 10 percent bonds. We started moving from an all-equity position in the first part of last year to a neutral 90–10 level toward late April of last year, and then held that through the summer months. In the fall, we started getting more defensive, bringing that equity weight to where it now is at 72 percent. That has helped our relative returns from the asset-allocation point of view. But also, within the equity fund, we’ve had very strong relative performance versus the benchmark target indexes.

{Q} What have you done on the equity side of the equation?

{CHALUPNIK} We overweighted the international component of the portfolio using the First American Funds International Select Fund and International Fund as a component of our equity portion. We took those weightings about 50 percent above our neutral level of 15 percent. Those offerings outperformed domestic stocks by a fair amount in 2007. Then, within our domestic equities, we overweighted large-company stocks and severely underweighted small-company stocks, which significantly underperformed large-capitalization funds. So the asset allocation that Keith was talking about worked out perfectly across the board.

{Q} How does asset allocation versus portfolio
composition of the funds within a fund contribute to performance?

{CHALUPNIK} Within the stock and sector selections within the funds, they did add value. In general, we were underweighted in financial stocks in the second half of 2007 and consumer discretionary stocks and retail. In general, we were overweighted in energy and technology. We were playing more of the late-cycle trends, based on international growth and the lower value of the dollar. We were underweighted in early-cycle stocks—financial and consumer—which benefit from borrowing when the economy picks up.

{Q} Why would an aggressive growth-allocation fund do better than something that was more conservative?

{HEMBRE} Part of that was just the timing of the allocations. While the overall equity market returns were quite modest, we were overallocated during the times of strength and under-allocated during the times of weakness.

{Q} In the equity portions of the fund, what other strategies Are you using?

{CHALUPNIK} We took good-sized positions in energy names, technology names—some of our bigger holdings in technology have been Hewlett-Packard [NYSE: HPQ], Cisco [Nasdaq: CSCO]—the companies that had dependable fundamental outlooks selling at reasonable valuations. The catalyst to the names being that international growth would drive earnings, with cash flows quite strong. That really has paid off.

The thing we’re thinking about now is shifting out of more of these late cycle names into more of the early cycle names. We still think it’s a little bit too early, but now we’re starting to look at the opposite way.