Strategies From a Top Mid-Cap Fund Manager

RON SLOAN LOVES competition — whether it was playing tackle on the University of Missouri football team in the late 1960s or running an equity portfolio today. Part of the appeal is the ability to keep score, he says.

For Sloan, it's also been mostly an enjoyable task.

Over the past year through September 17, his $1.8 billion AIM Mid-Cap Core Equity Fund (GTAGX) was down 2.99% while the market suffered more than a 20% loss. That put him in the top 4% of all equity funds and the top 2% of his mid-cap fund peers.

"By focusing in the center of the market in terms of both size and style," Sloan says, "we are offering a core portfolio for investors looking for secure long-term ballast."

And he's been doing that for a while. Sloan's up an average of 12.38% a year over the past decade, which is 7.70 percentage points better than the S&P 500. Sloan strives for consistency, not looking to hit home runs nor hesitating to close out losing positions. Right now, he's sitting on a hefty 20% cash position in a market full of potential opportunities.

His approach has worked well in previous bear markets. In 2001, Sloan was actually up a half-percent, topping the broad market by nearly 12%. The reason: He'd already rotated out of pricey tech and into energy and consumer staples.

The following year, the fund was down just 11.1%, half what the market lost. Sloan's conservatism may have cost him a bit when the market turned: He trailed the broad market by 1.6% in 2003 — though that still resulted in a 27.1% gain.

Originally from Kansas City and now working in San Francisco, Sloan, 61, doesn't think there are any shortcuts in investing. He's averse to momentum plays, far more likely to sell into a wave of buying. He's committed to thorough due diligence before putting a dime into a stock. And when a share price hits his target or strays from his investment thesis, it's gone.

"Before I took over the fund in 1998," Sloan recalls, "AIM was known for its growth and momentum approach. But I was interested in managing a fund that didn't take excessive risks and was capable of performing well across all kinds of markets."

This discipline is evident in his portfolio construction of 75 stocks. Whenever he adds a name, he'll yank his weakest holding to make room. To Sloan, managers who have hundreds of companies in their portfolios simply haven't been able to make up their minds.

Stocks have to compete for a place in his roster. Sloan uses a four-tier ranking system that establishes benchmark weights (there's ample room for variation). In theory, each of the top five represents 2.5% of the portfolio. Each of the next 10 stocks is weighted at 1.85%, the next 20 at 1.35%, and the last 40 at 1%. (The remaining 2.5% usually is cash.) This forces Sloan, along with co-managers Doug Asiello and Brian Nelson, to carefully gauge every stock they buy.

The one thing all his equities have in common is that they are quality companies with solid outlooks that he has been able to pick up on the cheap. He finds them with the help of five research analysts, who are given the chance to select stocks.

Director of Research Nelson and his analysts manage 15 stocks, and Asiello manages his own group of holdings. While Sloan has the ultimate say on the bulk of the portfolio, decision-making is collaborative. This is all part of Sloan's larger strategy of creating and maintaining a committed team that he compares to an extended family.

And there are natural family squabbles.

Asiello and Nelson saw the collapse of Legg Mason's (LM) shares over the past two years, creating a compelling buy. But Sloan was skeptical, as he is with most financials.

His co-managers, however, were far more confident about the stock, which by the spring was selling at a ratio of enterprise value to assets under management of just 0.60% (enterprise value is market capitalization plus net debt). "That was nearly a three-quarters discount to the rest of an already beaten-down industry average of 2.25%," says Asiello, who saw this as adequate cover for Legg's potentially troubled structured-investment-vehicle liabilities, client outflows and the performance problems of its once-star portfolio manager, Bill Miller.

With $920 billion of assets under management, Legg remains a major, highly respected, well-managed industry player. And it has unrealized synergies, say Asiello and Nelson, from the swap that gave it Citigroup's asset-management business and its acquisition of hedge-fund manager Permal Group.

So far, Legg has traded off more than 30% from the fund's average cost of more than $54. But the group hasn't blinked, still believing in its two-year price target of $86.

The investment in the Baltimore-based asset manager reflects a significant rebalancing out of the fund's profitable energy exposure — which had peaked at 15% early this year, and included FMC Technologies (FTI), Noble (NE), and Smith International (SII) — into financials. Since the spring, Sloan also has added People's United Financial (PBCT) (see "The People's Choice," Barron's, Aug. 25), Moody's Investor Service (MCO) and Progressive (PGR) as part of boosting his weighting in financials from 5% to 15%.