GREAT INVESTOR EXCLUSIVE Transcript 10/04/2013 #1015

October 8, 2013

CONSUELO MACK: This week on WealthTrack, ClearBridge Aggressive Growth Fund Manager Richard Freeman has been on the fast track for 30 years with no signs of slowing down. Where is this Great Investor driving the portfolio now? That’s next on Consuelo Mack WealthTrack.

Hello and welcome to this edition of WealthTrack, I’m Consuelo Mack. Where do you come out in the classic, Wall Street “growth versus value” debate?  When you look at your portfolio are there more value or growth stocks and funds?  What’s the difference between the two categories?  Traditionally growth stocks are defined as having higher than average earnings and sales as well as price/earnings multiples. Typically they pay little or no dividend. Value stocks are supposed to have slower growth and lower P/E multiples but pay higher dividends. Growth stocks typically perform better in bull markets. As you can see from this chart, they certainly have since the market bottomed in March of 2009. A benchmark Russell Growth Index has vastly outperformed the Value Index.

Value stocks are supposed to protect you more in bear markets. As a general rule they have.  But in the great equalizer market of the 2008-2009 financial crisis, both classes were hit hard. Warren Buffett would tell you growth and value are meaningless distinctions. Here’s how he put it in his 1992 Berkshire Hathaway Chairman’s letter: “In our opinion, the two approaches are joined at the hip: growth is always a component in the calculation of value, constituting a variable whose importance can range from negligible to enormous and whose impact can be negative as well as positive”.


This week’s WealthTrack guest could not agree more.  He is Richard Freeman, a founding Co-Portfolio Manager of the ClearBridge Aggressive Growth Fund which he now co-manages with Evan Bauman. The fund is celebrating its 30th anniversary this year and has outperformed the market and its peers in the large growth category over the last decade. Freeman has also been nominated twice for Morningstar’s Stock Fund Manager of the Year Award.  I began our conversation by asking Freeman why in retrospect he thinks the fund should never have been labeled “Aggressive Growth.”


RICHIE FREEMAN: We started it as the Shearson Aggressive Growth Fund back in 1983, and it’s not managed in an aggressive manner. I think it scared off a lot of people when they heard the word “aggressive.” It had negative connotations- rapid turnover, buying very risky stocks. If we could turn back the clock, which you can’t do, it probably should have been the Shearson Growth Fund.  We’ve been asked very often why don’t you change the name of the fund?  I think after 30 years it has an identity.  People realized the ClearBridge Aggressive Growth Fund is what it is. It should have been called the passive-aggressive growth fund.


CONSUELO MACK: Okay. Passive-aggressive.


RICHIE FREEMAN: That’s what it should have been.


CONSUELO MACK: Why passive… what’s passive about it?


RICHIE FREEMAN: The management style… if you look at the companies, they clearly could be called aggressive companies.  They’re state of the art. They’re lifesaving companies, companies that have products that can serve unmet needs, managed aggressively, but the way we manage the portfolio, we don’t have a lot of turnover.


CONSUELO MACK: Right.  8%, where your growth competitors…




CONSUELO MACK:…the annual turnover is 96%. So that’s incredible.


RICHIE FREEMAN: That’s the passive part of it.




RICHIE FREEMAN: I mean we’re not reticent to change the portfolio, but give us something that we like more than what we have in the portfolio. And this has really been constant over the 30 years of the fund.


CONSUELO MACK: So what is your mission at the ClearBridge Aggressive Growth Fund? If I’m looking at you and I’m saying, you know, should I invest with Richie Freeman and Evan Bauman, you know, what is it that I’m going to get from you?


RICHIE FREEMAN: The only mission that we have is to try to deliver good absolute returns over time. There’s a big preoccupation on the street with relative returns, benchmark investing. We’re benchmark agnostic.  We could care less what’s in the benchmarks.


CONSUELO MACK: So you don’t care what’s in the Russell 3000.




CONSUELO MACK: You’re not comparing your performance to that.


RICHIE FREEMAN: Well, we do.  You have to be compared to something. That’s the report card, but we’re not going to set up the portfolio looking to see what’s in the Russell. I guess the top ten holdings in the Russell, we own none of them. I mean Evan reminded me that our active share, which is the amount that’s not in the benchmark, is 95%, which is said to be very, very high. So over time, if you have good absolute returns, the relative returns take care of themselves.


CONSUELO MACK: And let’s talk about what you’re looking for, what you mean by absolute returns.


RICHIE FREEMAN: Absolute return is if we’re up 10%, and the market is up 11%, we’re not going to be apologizing for trailing the market by 1%. If we’re down five percent, and the market is down ten percent, we’re not going to be happy, even though it’s “good relative numbers,” because you’ve lost principal. Over time, we want to try to put up very strong absolute return, just to give the investor a good return.

I’ve always said, you know, from when we started it, we manage money for a hypothetical woman that lives in Iowa, a 75-year-old woman, never heard of the Dow Jones Average, never heard of the Russell, maybe heard of the S&P. All she wants to do is get a good return on her account. And she doesn’t want to be told, “You had a good year. You lost less than the ‘market.'”  She just wants to have a good return that she could use. I don’t mind if people take some of the money out that they’ve made over the years. They should be able to use and enjoy some of the proceeds.


CONSUELO MACK: So 1983, how did this happen?  Because you were an analyst.


RICHIE FREEMAN: I guess it was May of 1983, a very good friend of mine, Elliot Fried, who was the research director at Shearson, met him in 1976, he was a great friend. He’s a Wall Street legend, called me in May of 1983 that Shearson would be launching the Shearson Aggressive Growth Fund, would I be interested in managing it with him. And I’ve always wanted to manage money at the time.  I think most analysts always desire… the goal is always to manage money.  And it was the easiest phone call I ever had.


CONSUELO MACK: I’m just thinking of when I look at the profile of the fund, you know, we talked about the fact that it is a very low turnover. But the other thing that is really unusual about the fund is that it’s so concentrated. I mean you’ve got what? Half of the fund is in the top ten holdings. 35% is in the top five.  A third of the fund is in healthcare right now.  20% is in technology. You know, why are you running such a highly concentrated portfolio?


RICHIE FREEMAN: When a lot of those companies started out in the portfolio, they were very, very small. They were microcaps. Idec Pharmaceuticals, in 1991, was a microcap name.


CONSUELO MACK: And it’s now Biogen Idec.


RICHIE FREEMAN: Now, it’s Biogen Idec.


CONSUELO MACK: It’s now, what, 11% of your portfolio? So tell us the story of… and this is kind of the story of how you invest as well. Of how it happened that it’s now 11% of the fund.


RICHIE FREEMAN: I think it’s emblematic of how we look at companies. The CEO of Idec had come out of Genentech.  Genentech was the first stock that we ever bought, October 24th of 1983. So I saw Bill Rastetter was over at Idec Pharmaceuticals. We looked at it. We liked the product that they were involved in. It turned out that the initial product of theirs failed.  They then teamed up with Genentech to design clinical trials on Rituxan, as it turned out, which is a blockbuster drug. We bought the bulk of our stock in 1995, because it had the characteristics of what we like. They were serving a medical need.  It could really make a difference in people.

The company can serve a very large market, a top-tier management team, backed by a very, very strong partnership in Genentech.  And in retrospect, we got awfully lucky, because they merged with Biogen in the early 2000s.  And it’s been a very, very fortunate stock. But then, again, it has the characteristics, not just in healthcare, but be an oil company like Anadarko, or a cable company like Comcast.


CONSUELO MACK: Right.  Again, these are your top five holdings.


RICHIE FREEMAN: It throws off a lot of free cash flow.  I don’t understand why any investor would make an investment if he didn’t think over time the company would not generate cash, because that’s what you’re left with.  At the end of the day, you want companies to generate cash, and the biotech companies had that ability.  Not early on, when they were consumers of capital, but over time, they’ve been enormous generators of cash.


CONSUELO MACK: But what I don’t get, Richie, is that you’ve held these stocks, as you said, some of them since the 1980s, some since the 1990s, but you’ve ridden these stocks up and down.  So, you know, what happens when you’re in the midst of like a financial crisis, or the crash of ’87, and you’re holding these companies? And I know you’ve gotten, I’m sure, flak from your investors in saying, you know, what are you doing, Freeman? You know, the stock is down X percent. What do you do in a situation like that?


RICHIE FREEMAN: I heard it very often from my wife in 2008, in fact.  If you look at the market over time, you understand the market is going to fluctuate. I mean Joe Granville always said, “Stocks are like people.  They have to breathe.” And as long as you have a sign curve in an upward direction, that should be the goal, but there are going to be periods of time when you’re going to be hit with unexpected negative news.  Call it headline risk.

We owned a company, Chiron, a biotech company, which singlehandedly, in retrospect, caused the flu vaccine shortage about seven years ago. A plant that manufactured the vaccine for them was contaminated in London, had to pull the supplies, shut down the … essentially cut off a lot of the flu vaccine in the U.S. The stock plummeted. A lot of investors worried. We looked at what the company was worth, exing out the flu business, and we thought that the valuation was incredibly compelling, and added to it.  Luckily then, Novartis came along and acquired them a couple of years later.

Biogen Idec, which we mentioned, is another company that’s been through headline risk.  They had a drug, which they voluntarily pulled off the market six years ago, because it had some side effects.  It was then put back on the market. The stock had fallen to a level which we think removed any value for that drug, and the company has gone on to make all-time highs.  Anadarko Petroleum, another headline risk company, they had a 25% investment in the Macondo Well, which they were right, there was a lot of oil in that well, except it was flowing into the ocean, as opposed to into the pipes. The stock fell precipitously. We took a look at what the valuation of Anadarko would be under a worst-case scenario, and we thought that the valuation was more than being discounted by the stock price coming down. So we held onto Anadarko, and it’s come back and made all-time highs.


CONSUELO MACK: So let me ask you about, when you’re talking about headline risk, you’re sounding like a value investor to me, like a deep value investor.  So when you have headline risk and the stock goes down, do you buy up, do you double up, or do you just hold it? I mean what’s your strategy?


RICHIE FREEMAN: Well, the one thing that a growth investor hates is when his stock becomes a devalued stock.




RICHIE FREEMAN: Right. But you have to look at it, after the news is out, you have to take a look at reevaluate it. What is it worth today, with all the information that’s out there? Wall Street is very emotional. Wall Street tends to over discount events, and tries to over… when things are going good, they’ll always overshoot, and vice-versa on the downside. So we try to become unemotional, in a very emotional business, and we try to make the best judgment where this company is going to be, you know, two to three years out.


CONSUELO MACK: According to Morningstar your risk profile is high on the fund. The fund captured 109% of the Russell Growth Index in the upside, in the last decade, but it also suffered 112% of decline. So is volatility, that’s just the name of the game with a growth fund? How do you explain that?


RICHIE FREEMAN: Volatility is just a byproduct.  It’s nothing that we’re going to control.  What we care about at the end of the day of the companies, and if we’re able to put up strong numbers, we’ve been very, very fortunate, we try to buy great companies. Great companies, over time, will become great stocks. A lot of people buy great stocks thinking that they’re great companies, and it doesn’t work that way. I mean a great example is Facebook.  You know, we thought that eventually this could be a great company. We thought it was a great company when they came public.


CONSUELO MACK: Let me stop you there.  So tell me about why you decided to buy Facebook. And you bought it at the IPO, is that right?


RICHIE FREEMAN: We bought 100,000 shares at the IPO, at 38.


CONSUELO MACK: All right. Initial Public Offering, right.


RICHIE FREEMAN: Yes.  We thought that at over a billion users, we thought it was a sticky product. We didn’t think it was a fad. We thought it was a powerful trend. You contrast that with MySpace, from a number of years ago. We liked the management team. The CFO of the company has been in our office when he was with Genentech.  He was the CFO of Genentech.  And the IPO, in retrospect, was an enormously successful IPO.  When people hear that, they say, “How are you saying that?  The stock price declined.”  Well, it was very successful for the company, not so much for the people that bought it at 38. Then, unfortunately, many of them sold it lower.


CONSUELO MACK: Including you, who bought it…


RICHIE FREEMAN: Yeah.  That’s right.


CONSUELO MACK: … at the initial public offering price.


RICHIE FREEMAN: Guilty, as charged.




RICHIE FREEMAN: But, for us, that was a small position. We have a number of positions, maybe 20 positions, that are going to be very small, relatively small in the portfolio. We’ll call it the bullpen, where by putting it in the portfolio, we will watch them much more closely. Either we can sell it, if we don’t like what’s developing, or we can build it into a bigger position, if the price is right, and if we see certain things happening. The lockup ended. Many of the insiders were selling at …


CONSUELO MACK: And didn’t that distress you at all? I mean isn’t that a sign that you should be getting out, too, if they’re bailing out?


RICHIE FREEMAN: We actually welcomed it, in that sense …




RICHIE FREEMAN: … because our work told us that they weren’t losing any share.  They thought there was a chance that Wall Street was looking at this company incorrectly. Target advertising is an explosive area, and it wasn’t being looked at correctly. We bought probably 2-and-a-half million more shares. Our cost basis is about 24. So in retrospect, it’s been a lucky holding, because we never thought it would rally back as fast as it did.  But that’s an example of headline risk. Headlines are good for selling newspapers, not for making money on the stock market.


CONSUELO MACK: So in the bullpen, which I love that concept, I mean how many stocks do you have in the bullpen that you have small positions in, and you’re…


RICHIE FREEMAN: Small position defined is probably 40 basis points, 50 basis points.  We have, you know, a dozen or so, but they’re small. We usually don’t talk about…


CONSUELO MACK: You mean just a half a percentage of the portfolio? Is that …


RICHIE FREEMAN: Well, now Facebook is probably a little under 2%, but it was very small when we first bought it, because we weren’t going to bet the ranch at that price.


CONSUELO MACK: So in the bullpen, I mean are there any stocks that are relatively new holdings that you think that with confidence that if things go the way you think they’re going to go that they’ll be in the portfolio in 10 years, or in 20 years?






RICHIE FREEMAN: We don’t know.  We don’t know things are going to be developing, but if we see the things … if we feel more comfortable, and it’s not being reflected in the stock price, you know, we’ll add to them.  That’s what we did with Genzyme, which we first bought back in 1989.  I remember doing it with AM General, so in the 1980s. They started out as small positions, but certain things developed. The stock prices didn’t skyrocket before we added to them, and, you know, we got lucky.


CONSUELO MACK: Right.  You know, Biotech, big holdings of yours. United Healthcare is a big holding.  So explain the United Healthcare story. I guess it’s what, number two?




CONSUELO MACK: Your second largest holding. 8% of the portfolio.


RICHIE FREEMAN: Bought U&H in 1991. It was a premiere health company. We also owned U.S. Healthcare at the time. We bought United Healthcare and U.S. Healthcare.  U.S. Healthcare was acquired by Aetna. United Healthcare grew dramatically through acquisition. It has all the characteristics of a company that we look for- great management, large addressable market, they throw off an enormous amount of cash. And they’re shareholder friendly. They return cash to us as dividends. I mean dividends never accounted for anything in this fund. The yield was always NM, non-meaningful. U&H now pays almost an S&P kind of dividend. It’s been raised significantly. And they’ve been buying back billions of dollars worth of stock, and the earnings per share have grown nicely.


CONSUELO MACK: So, again, this is a growth fund, and you own United Healthcare. So, you know, at what point does… you know, does that fit your growth profile?


RICHIE FREEMAN: To me, a growth stock is a stock that goes up, period.  That’s the goal.  People always, they try to make the distinction, as you said, between growth and value.  A growth stock is one that we think could advance in price.  People always try to pitch it all the same, what criteria to use, it has to sell at under 20 times earnings, more than 30 times earnings.  We like to buy them if they’re selling at … ideally, if you can buy a company at less than its growth rate, that’s throwing off so much cash that they can buy back stock, pay you a dividend, invest in other companies, and grow that way, that’s the triple play.  That’s the homerun.


CONSUELO MACK: So when do you sell a stock?  Do you sell stocks?


RICHIE FREEMAN: Well, we have a turnover, so 8%…


CONSUELO MACK: I know you do 8% a year, right.


RICHIE FREEMAN: We have a lot of involuntary turnovers, when you have takeovers.  And you mentioned the biotech area, we’ve had … many of those companies have been part of our turnover over the years. Genentech was acquired. Chiron. Gensyme. ImClone was acquired. Millennium Pharmaceuticals. We had Gen-Probe, that had been acquired. Genentech, itself, as I said, was acquired.


CONSUELO MACK: Right.  And, of course, those were all positives, because when a company is acquired, they’re usually acquired at a premium.


RICHIE FREEMAN: And those are always surprises, you know. I’m always the most surprised guy when that happens. And also, when names get to be too large a portion of the portfolio, we will trim them down.


CONSUELO MACK: So I’m just looking, and so Biogen Idec at 11% is not too big…


RICHIE FREEMAN: It’s been trimmed …




RICHIE FREEMAN: We have sold over the years, you know, quite a bit of that stock, because it’s up dramatically, to try to keep it at roughly the 10% area. We had taken some off the table.  Anadarko Petroleum. Genentech. Years ago, we sold a lot, when it was over that 10% level.  U&H, as well, was over ten percent. We trimmed it down.  And there are other instances where we’ll sell a stock, if we think the risk reward is poor. We had Oracle. We bought Oracle and Lotus the same day in 1991. Lotus was acquired by IBM in mid-1990s. Oracle, we started selling in 1998, and sold the rest of it in 1999.




RICHIE FREEMAN: Based on just purely on valuation.  Just felt that if they would ever miss earnings, and we had no reason to believe that they would, if they would ever miss earnings by a couple of pennies, the stock, based on its valuation, would suffer dramatically.  So I remember after selling Oracle, the stock probably doubled in the next year, before going down 80% after that, and the breakdown of 2000 and 2001.


CONSUELO MACK: Biggest investment mistake you’ve made in the portfolio?


RICHIE FREEMAN: There’s only a half-hour.


CONSUELO MACK: Or in life.


RICHIE FREEMAN: This is only a half-hour show, isn’t it?


CONSUELO MACK: But is there one big mistake that you made that you really learned a lesson?


RICHIE FREEMAN: In the year 2000, I think the fund was up a little over 19%, but we were up …


CONSUELO MACK: One-nine or nine …




CONSUELO MACK: 19, right.


RICHIE FREEMAN: At one time, I think we were up over 30% that year, and gave back some.  Even though it looks greedy, you’re up a lot in a down year for the market, it still, to this day, bothers me that I didn’t take more off the table.


CONSUELO MACK: You’ve been through booms and busts. You’ve been through the ’87 crash.  You’ve been through the Great Recession, the financial crisis, whatever.  So what’s changed in how you invest? Has anything changed?  I mean how have you adapted to these various …


RICHIE FREEMAN: I think the biggest difference is when you speak to companies, they’re not as helpful as they were back before the advent of full disclosure.  So you just have to find other ways to invest. I mean you can’t call up the IR person and expect to find out what the orders are every month, because that’s not legal. So, obviously, it’s not done now.  You didn’t have computers back then, where everybody had access to the internet.  If you wanted to do research on a company, you had to call up the company to get the annual report sent to you. Now you can just go to your computer, get all the information. Companies, when they put out events, will put out a conference call, so everybody at the same time has access at the exact same moment.


CONSUELO MACK: So the competitive advantage that one used to have, if you had big holdings, or whatever, is gone.


RICHIE FREEMAN: But we still find ways to do okay. Because at the end of the day it comes down to how do you value companies, period, and that hasn’t changed. And I think one of the negatives that’s happening now versus years ago, I think the public almost feels that they’re compelled, from watching a lot of shows, and not this one, and that’s why I like this one, they’re almost compelled the public to make trades.  What are you doing today?  How are you trading the market over the next couple of weeks?  How are you going to react to the budget deficit?  To me, that’s not the way to make money for the long term. You try to identify great companies. You monitor them closely. You increase your positions, if the market accommodates you, gives you some weakness. You cut back into extreme strength. And don’t be scared out of positions by a lot of macro events.


CONSUELO MACK: So during the financial crisis itself, which, you know, was kind of a near-death experience for many portfolio managers, and certainly, you know, you suffered as well, is there anything that you’re doing differently as a result of what happened in the financial crisis?


RICHIE FREEMAN: I would say no.  And the only way you can really tell, you ask a manager did he change his portfolio, did he change what he did after the crisis, and he’ll say no. But then you ask for his turnover, and if his turnover changed appreciably, then you know he really did make some changes.

Our turnover didn’t change afterwards, so some of the stocks that clearly hurt us on the way down have been some of the biggest beneficiaries in the portfolio.  Seagate got down to two-and-three-quarters, as did Liberty Media, back then.  Liberty Media went from 18 to two-and-three quarters. The John Malone Company. And, you know, we got lots of questions from clients. I mean how do you justify charging us a fee when you have Liberty Media go from eighteen to two-and-three-quarters?  You know, we held on to it.  Liberty Media now is 145, not including distribution of Stars Entertainment that they gave us for another $27. I mean that’s an extreme example, but it’s… if we would become more conservative afterwards, as a lot of people did, we wouldn’t have had the benefit of the recovery.


CONSUELO MACK: One Investment for a long-term diversified portfolio. We always ask our guests this at the end of every WealthTrack. So what would you have us do, or what would you have us own, Rich?


RICHIE FREEMAN: Hall of Fame golfer, Lee Trevino, tells a story, which I think is applicable to this show.  He said the most nerve wracking thing is when you have a $10 putt with just $5 in your pocket.  In other words, you better be perfect.  When people run up a lot of debt, they have big mortgages, a lot of credit cards, that’s okay as long as a lot of money is coming in, there are no financial problems, but what happens if, you know, something changes?  So I’ve always told people debt is the dirtiest word in the financial business, dirtiest four-letter word.

A lot of people don’t agree with me, but I will always say, even for younger people, if they’re able to, pay down your mortgage, if you’re getting money in. Pay down your credit cards. Try to remain as low debt as you possibly can, because I think you can make better judgments if things do get rocky. So I feel very strongly about that.


CONSUELO MACK: Relate that to your investment management approach.


RICHIE FREEMAN: If you look at the holdings in the portfolio, you look at the balance sheets, you have companies like Forest Labs, with $12 a share in cash, no debt, you have Biogen Idec, that was able to make a $3 billion acquisition for cash this year, because they’re throwing off billions of dollars of cash, with no debt.  Anadarko doubled their dividend.  They generate a positive free cash flow.  Comcast was able to buy the NBC Universal venture, because they’re throwing off so many billions of dollars of cash flow. To me, cash is the most important thing.  It’s what every investor should be striving for.

Why do you want to own companies that are debt ridden, that are consistently worried about rolling over debt?  You want to try to control your destiny.  Now, there are going to be events like 2008 that will pressure a lot of companies, and if that’s the case, you want to have companies that, as best as they can, can control their destiny.  They don’t want to be beholden to the person that they’re rolling over money from, so that’s how I feel.


CONSUELO MACK: Great point.  Rich Freeman, such a treat to have you on WealthTrack.  It’s the 30th anniversary of the ClearBridge Aggressive Growth Fund.  We really appreciate having you here.


RICHIE FREEMAN: Love your show, Consuelo.


CONSUELO MACK: At the close of every WealthTrack we try to give you one suggestion to help you build and protect your wealth over the long term. This week’s Action Point is: don’t get hung up on investment labels. As we just heard from Richie Freeman the “Aggressive Growth” label on his fund, given 30 years ago at its launch, is a misnomer and does not describe the nature of his fund which seeks stocks that offer the best absolute returns over time. And unlike many other so called “growth” funds Freeman’s portfolio has an extremely low turnover, not a characteristic of a typical aggressive growth portfolio. So your best bet is to know a fund’s investment objectives and approach and if it has successfully achieved them over time.


I hope you can join us next week. Gluskin Sheff’s influential economist and strategist David Rosenberg is reversing his 20 year deflation call. He says we are entering a new era. He’ll tell us why, and what it means for investors. Until then, please visit our website to see past WealthTrack episodes. Additional interviews with our guests and valuable research from our sources are available on WealthTrack Extra. And feel free to connect with us on Facebook and Twitter. In the meantime, have a great weekend and make the week ahead a profitable and a productive one.

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