Fund name: Leuthold Undervalued and Unloved (UGLYX)

Objective: The fund seeks long-term capital appreciation and dividend income. The fund invests in common stocks of companies which pass at least six elements of a seven element quantitative screen. The screen includes:

• Five year retrospective P/E under 12
• Price to book ratio under 1.75
• Dividend yield of 3% or more
• Long-term debt (plus unfunded pension liability) to total capital ratio under 50%
• Price to cash flow less than 70% of the S&P500’s ratio, except in the case of certain financial industries where comparable measures are substituted
• Cash per share to price per share ratio of 10% or more
• Financial strength must be "reasonably good"

Adviser: Leuthold Weeden Capital Management (LWCM) of Minneapolis, Minnesota. The firm is a subsidiary of The Leuthold Group which was founded in 1981 to provide "independent, quantitative and contrarian institutional research" for institutions including money managers, hedge funds, pension funds and the like. But not for po’ folks. In any case, the strength of Leuthold’s research led them to open a money-management arm in 1987. LWCM now operates six mutual funds with nets assets around $1.7 billion and private investment portfolios for folks with a million or more to invest.

Managers: James Floyd and Eric Bjorgen. Mr. Floyd has been with Leuthold as analyst since the firm’s founding. Mr. Bjorgen joined the firm in 1998 and helps manage the Asset Allocation Fund, Core Investment and Select Industries Fund, and provides analytical support for the Grizzly Short Fund.

Inception: November 14, 2006.

Minimum investment: $10,000 for regular accounts, $1,000 for IRAs.

Expense ratio: 1.50% after waivers, although only 1.60% even without the waivers. There’s also a bizarre 2% redemption on sales of shares held fewer than five days. Five days?

Comments: The Leuthold Group is among the industry’s preeminent research outfits. They’ve tracked an enormous amount of data (some 140 market indicators) for a couple decades now, and use that data to build models which are used in their asset allocation funds. At any given point, some of the models are not in play while others are. The tendency to incorporate the right model for the moment means that the asset allocation funds necessarily contain a strong element of momentum, which then tends to heighten their short term volatility. "Undervalued and Unloved" is one of the models that Leuthold developed to select value stocks. The model has been used tactically in the asset allocations funds as a way of dampening volatility and capturing value.

Undervalued and Unloved is now being offered as a free-standing fund. They offer a couple reasons for the timing of this launch. First, they’ve been beefing up their information technology capabilities (e.g., they’ve developed models which allow them to trade more efficiently) so that they can handle more money now. Second, it made sense because they had already launched their new Select Equity and Asset Allocation funds. What’s the tie? Simple, Undervalued and Unloved and Select Equity are the two equity selection approaches used in the Asset Allocation fund. Having already launched yin, it made sense to them to launch yang.

It’s clear that the fund makes sense for Leuthold. The question is whether the fund makes sense investors. There are at least three factors in its favor:

1. The strategy has succeeded. Over the past 30 years, this particular screen has outperformed the S&P500 about 75% of the time and has cumulatively returned about three times as much an investment in the S&P 500 would have: about 7700% price return for U&U versus 1800% for the S&P. On an annualized basis, that comes to 15% versus 10% before dividends are figured in.



2. The strategy has some downside protection. At one level, almost all of the equities in the fund will have dividend yields north of 3%, about 50% more than the S&P average. The fund’s investable universe is diversified across industries and market caps (as of October, about 25 large caps, 35 mid-caps and 43 small caps). And the fund’s selection strategy – cash-rich firms with beaten-down stocks – produces a fair number of candidates for buyouts or acquisitions, which can occur regardless of the market’s direction. In any case, a lot of the downside for the stocks is already built in at the point the fund purchases them. Usually. They hope.



3. Leuthold does good work. These folks communicate effectively with their shareholders. They’ve been disciplined in their investment strategies. And they’ve closed their funds before asset bloat compromised their strategies.

There are some concerns worth considering. First, value has been outperforming growth for about six years. That’s an unusually long stretch, so new investors might be buying near the peak of value’s run. That said, with the exception of the last two years of The Bubble, very strong years for the S&P (that is, years with gains of 20% or more) have also been very strong years for their strategy. Second, the fund’s investment universe can get cramped. Leuthold shared with me the list of currently qualifying companies and the historic averages for the numbers of companies clearing their screen. In their tightest years, only 27 companies were investable. On average, since 1990, the investable universe has been 57 companies. Currently it’s 122. Mr. Bjorgen’s response to the concern is to note that the prospectus gives the managers leeway to hold on to appreciated stocks even if they’re not undervalued anymore. They’re held, he notes, on a very short leash but they don’t need to be sold immediately.

Bottom line: The expenses here are reasonable and that model appears to work. While the investment minimum ($10,000) is rather higher than I’d personally like, folks who are looking for value exposure and like the discipline of a quant approach should take this pretty seriously.