Morningstar Magazine - February/March 2015 - 78

Investors

Disciplined Growth Investors DGIFX
Category

Moderate Allocation

Expense Ratio (%)

0.78

Morningstar Rating

QQQQQ

3-Yr-Annl Total Rtn (%) 16.6
3-Yr Total Rtn % Rank

Data as of 12/31/2014.

the equivalent separate account-the managers
sold energy stocks and most lenders heading
into 2008, then sold Treasuries that year and in '09
and used the proceeds to buy stocks-the
retail fund has struggled at times during down
markets, particularly the second quarter of
2012 when stocks such as Advanced Micro Devices
AMD, Select Comfort SCSS, Plexus PLXS, and
Eaton ETN underperformed.
Generating Returns

Many moderate allocation funds are designed to
be rather conservative, protecting capital
when stocks dip and at least participating in rallies.
Given that backdrop, this fund gets an advantage
from its emphasis on growth stocks. The strategy's
average 38% exposure to technology stocks
over the past three years is almost three times that
of the typical moderate allocation fund. And
that, in turn, has been a crucial driver of returns.
The fund's 16.6% annualized gain the past
three years has largely come from tech stocks such
as Seagate Technology STX and Yahoo YHOO.
While tech stocks have given the strategy a
powerful performance boost, the managers have
also done well with holdings in other areas.
Clothing retailers TJX Companies TJX, parent
company of T.J. Maxx and Marshalls and currently
the fund's top holding, and L Brands LB , which
controls the Victoria's Secret chain, have both
doubled the past three years. Edwards Lifesciences
EW, a leading heart-valve manufacturer, has
also been a top performer. Those gains overshadowed disappointments such as Noble NE, Ultra
Petroleum UPL, and Paragon Offshore PGN.
More recently, stocks such as Akamai Technologies AKAM and Garmin GRMN contributed

Morningstar February/March 2015

to the fund's 11.8% gain in 2014. The managers
were attracted to Akamai's clean balance
sheet, vast network of servers, and by the fact that
it is now installing software on top of Internet
infrastructure, making it an important cog
in moving data along networks. "It's the WD-40 of
the Internet," Nicoski says. Martin, who is an
amateur pilot, was originally attracted to Garmin
because of its airplane navigation products.
Martin says the company is moving beyond that
niche into larger jets, smartwatches, marine
and auto GPS, and a camera that will compete
with GoPro. "It should have a new product a year
for the next three years," Martin says. Those
stocks were up 35% and 20%, respectively, in 2014.
Corporate Culture Matters

Morningstar evaluates a fund's corporate culture
starting with its board of trustees. Disciplined
Growth Investors' board is part of the ALPS series
trust, a structure where a board oversees several
funds from different fund companies. There are
some concerns with such a structure. Trustees can
be stretched thin. But, it is also a way for small
funds to keep costs low and to allow managers to
focus on stock-picking versus back-office roles.
One red flag with this structure is high fees. But
in this case, the fund's 0.78% fees are rated
Below Average. The category average is 1.01%, and
the comparison group median is 0.92%.
Ownership is another important aspect of
assessing corporate culture. At 52%, Martin has
the largest ownership stake in the firm. That
percentage has been higher the past decade, but
he has sold some of his stake to employees.
Link and Nicoski have 15% and 13% ownership
stakes, respectively. Martin sold down his stake

as a way to cash out his ownership without the aid
of an outside investor. More importantly, though,
he says he used it as a way to retain talent.
Ownership in the fund, though, had been lacking.
According to the fund's latest Statement of
Additional Information, none of the managers have
sizable personal investments in the fund. Martin
says the team and other employees are invested
in a separate account that follows a similar
strategy. He also says he has transferred more
than $1 million of his own money into the fund that
will show up in the next SAI. Other managers
are following his lead.
Disciplined Growth Investors awards bonuses
based on relative performance versus certain
benchmarks and absolute performance. That 50%
of bonuses are also based on absolute returns
is unusual. That means managers may not be
rewarded for simply limiting losses to less than the
market. Such a stipulation isn't common.
Finally, the firm attempts to round out its culture
by awarding one-month sabbaticals and, on
occasion, giving employees $2,000 to try something they never have before. One employee
used her sabbatical to research stress relief and
another used the $2,000 to travel to Costa Rica.
All of that, Martin says, helps develop a culture
where employees feel compelled to stick around
even though they likely could make more money at
a larger firm. "I wanted to give them a stake
in building the firm," he says. "They have to feel
they are important." K
Rob Wherry is the associate editor
of Morningstar magazine.

Morningstar Magazine - February/March 2015

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