Morningstar Magazine - February/March 2015 - 76

Investors

A Contrarian Bent
Disciplined Growth Investors' managers
have built a moderate allocation strategy
unlike most others.

UNDISCOVERED MANAGER

Rob Wherry

In every issue, Undiscovered Manager profiles
a manager on the Morningstar Manager
Prospects list, which is compiled by Morningstar's
manager research group.
The management team behind Disciplined
Growth Investors DGIFX doesn't mind being
a bit contrarian.
Take, for example, the strategy's portfolio. As its
name suggests, portfolio managers Fred
Martin, Scott Link, and Rob Nicoski, who have
run the fund since its 2011 inception but
have worked together for more than a decade,
favor attractively priced growth stocks across parts
of the market-capitalization spectrum, especially
those companies that can generate an annual
12% return over a seven-year period.
An emphasis on fundamental research means
the managers don't obsess over sector exposures
relative to an index as long as the thesis on a stock
makes sense and the portfolio is sufficiently
diversified. The strategy's distinct sector weightings-it has a 40% exposure to technology
stocks, more than two times the typical peer-
along with a bond sleeve designed to insulate it in
down markets, distinguish it from typical
growth funds and moderate allocation peers.
The managers break from convention when
it comes to conviction, too. The strategy's portfolio
turnover has averaged roughly 10% a year since
its launch, compared with 67% for its average peer.

Morningstar February/March 2015

That low turnover is an indication of the managers'
confidence in their research, so much so
that at times their clients have questioned their
decisions. Indeed, in separate accounts that
follow a similar strategy, they initiated a position
in Apple AAPL-in May 1998 at a split-adjusted
average $1.09 a share, long before the firm's streak
of popular product launches sent its shares
soaring. At the time, the managers believed in
Steve Jobs' skill as a CEO and the Apple brand, they
liked the improved financial condition, and were
intrigued with the adoption of the Internet, among
other reasons. The managers only recently sold
Apple in both the separate accounts and the fund.

likely avoids roughly 40 basis points in additional
fees by requiring investors to open up an
account with the firm instead of on the platforms.
The fund's 0.78% annual expense ratio is
rated Below Average, a rarity for an offering
with just $107 million in assets. The firm
also believes not listing on the platforms likely
helps it avoid performance-chasing investors
who wouldn't be willing to stick around for the
long haul.
"We are really careful who we take on. Investment
objectives are more important than business
objectives," says Martin, who founded
the firm in 1997. "Our clients trust us enough
to let [our stocks] play out."
Breaking from the pack has worked in
the strategy's favor so far. Its 16.6% annualized
gain the past three years through Dec. 31,
2014, puts it atop Morningstar's moderate
allocation category, and it beats the average peer
by roughly 6 percentage points.
"We don't spend much time on what other people
are doing," Martin says. "We just try not to do
stupid things."

We are really careful who we take
on. Investment objectives are more important
than business objectives. Our clients
trust us enough to let [our stocks] play out.
Fred Martin

The team has also resisted marketing the fund
using traditional tactics. Parent-firm Disciplined
Growth Investors decided not to list the
fund on Schwab's or Fidelity's mutual fund
platforms. Those platforms make it easy
for investors to find and buy shares of thousands
of mutual funds in one convenient place. But
that convenience comes with a price. The fund

Problems With Comparisons

This strategy isn't likely to be pigeonholed. While
it adheres to many of the tenets of a traditional
growth fund, the managers aren't likely pay up for
that growth, a tactic more akin to value managers.
The fund's 22% bond stake is the key reason
why it falls into the moderate allocation category.
But that stake is somewhat static. The team

Morningstar Magazine - February/March 2015

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