Fund name: Auer Growth fund (AUERX)

Objective: The fund seeks long-term capital appreciation by investing primarily in a diversified portfolio of common stocks traded on major U.S. exchanges. The portfolio is constructed through a quantitative screen which identifies companies that report substantial sales and earnings growth over the prior twelve months, plus a price to earnings ratio that has decreased substantially during that time. The managers are agnostic as to capitalization and value/growth distinctions.

Adviser: SBAuer Funds, LLC, of Indianapolis. SBAuer is an outgrowth of a collaboration between Sheaff Brock Investment Advisors and the Auers. Sheaff Brock is a registered investment adviser with about $275 million in assets.

Managers: Robert Auer and Bryan Auer. Robert Auer is the founder of SBAuer. Between 1986 and August 2007 he managed 350 separate accounts and served as Vice President of Investments for Morgan Stanley. For eight years he also had a weekly investment column in the Indianapolis Business Journal. Robert Auer handles the fund’s day-to-day management. Bryan Auer, his father, used to run a specialty chemical business. Since 1986 he’s been a private investor. Currently he serves as an advisor to the fund. On the day I called, he and his son were "noodling over stocks together."

Management’s Stake in the Fund: Well here’s a vote of confidence. The senior Mr. Auer’s retirement nest egg represents roughly $34 million of the fund’s $64 million in assets. The younger Mr. Auer has invested more than $1 million in the fund.

Opening date: December 24, 2007.

Minimum investment: $10,000 for regular accounts, $4000 for IRAs.

Expense ratio: 1.90% after an expense cap which is effective through November 30, 2010. There’s a 2% redemption fee on shares held less than 90 days.

Comments: I’ve never been quite so tentative in writing a fund profile before. Here’s the story, and the source of my concern. In the middle 1980s, Bryan Auer began experimenting with various stock selection strategies in his personal accounts. They were modestly conventional (buying and holding blue chip stocks, for example) but not terribly successful. He finally hit upon a variation of a value-conscious momentum strategy that suited him and worked well. He was looking for companies whose stock might double in a year. Then, as now, he screened for companies that met three conditions:

• 25% growth in quarterly earnings, year over year
• 20% growth in quarterly revenues, year over year
• p/e ratio under 12, although Auer makes his own "e" calculation

That typically generates a list of 600 or so stocks. He filters that list with a second set of nine criteria that helps identify the firms with the best growth prospects. About 200 stocks survive the second set of screens. He buys every stock that meets those 12 criteria. The amount he buys is determined by how well the stock did in meeting the criteria; a stock that just barely meets all 12 criteria still gets purchased but in amounts far smaller than a stock that blew past a bunch of the screens.

He sells a stock the minute it meets either of two conditions. He sells if it no longer meets his high growth criteria and he sells if the stock doubles. In doing this, he consciously rejects Peter Lynch’s advice to "look for ten-baggers" – that is, stocks which might increase 1000% in value – for the portfolio. Auer reasoned that many stocks double, that few maintained their new price level, and that almost none became ten-baggers. As a result, he decided to sell quickly rather than get greedy.

That strategy has worked well for him.

Really well.

Uhhh . . . really, really well. His initial $100,000 investment has now grown to $34,000,000. That means that, over the past 20 years, his portfolio has grown at an annual rate of 30%.

How does that compare to the competition? The best mutual fund in existence for those same 20 years was Vanguard Health Care (VGHCX), which returned an outstanding 16.8% annually. At that rate, $100,000 would have grown to $2.6 million. An enormous gain, though $31,000,000 short was what Mr. Auer earned. It’s also the case that the account's 15-year returns dwarf those of the best performing funds. Blackrock Global Resources and Jennison Natural Resources both have 15-year returns around 18% while the Auer account has never returned below 20% in a 15 year period and has, on some occasions, exceeded 40% annually for 15 years.

Happily, the 30% return over the past 20 years does not appear to be an anomaly. The fund reports quarterly performance data for Mr. Auer’s account since inception, and calculates the 1- to 20-year returns for each quarter. You can, for example, calculate what return you would have earned had you been able to invest in the account immediately before the October ’87 crash and then pulled your money out in panic after the 9/11 attacks (you would still have earned about 26% per year). To give you a sense of the consistency of the returns, here’s the range on rolling 10-, 15- and 20 year returns for the account:

The good folks at Kiplinger.com have described the fund as "wildly volatile" ("Superb Record Put to the Test," April 17, 2008), which doesn’t strike me as quite accurate. By the fund’s calculation, the Auer account captured 170% of the market’s upside but only 34% of its downside. That is, if the market rose 10%, the account tended to rise 17.4% but if the market fell 10%, the account tended to fall only 3.4%. Kiplinger’s points to the fact that the account lost "as much as 26% in a single quarter." Actually, the greatest quarterly loss was 29.8% (4Q 1987) but such losses are rare. The account dropped by 20% or more during four of the past 81 calendar quarters. It climbed by 20% or more in 12 quarters. In addition, it completely ignored the market collapse in 2000 – 2002 with gains of 15 – 50% over those three years.

So, is there any reason not to grab your PowerBall winnings, take out a second mortgage, or auction off a kidney to invest with the Auers? I can think of four serious reservations to keep in mind:

• The track record has been accumulated in a single retirement portfolio. Admittedly, that portfolio was audited carefully enough that the SEC allows its performance data to appear in the fund’s prospectus. And the newly-launched fund is off to a blistering start: as of a May 27, year-to-date it was ranked 4th of 1805 large growth funds in Morningstar’s rating system. Given that the fund currently holds very few large growth stocks, Morningstar is reclassifying the fund as "small growth" in June, where they also rank as one of the top 5 funds. But he’s never had to deal with fickle, or panicky, investors yanking money during a 20% down quarter.



• The strategy is apt to be a tax nightmare. The fund turns over its portfolio at a rate of 100-200% per year and will, the management agrees, generate "lots of short-term gains." If a $10,000 portfolio (the investment minimum) generates a 25% return, almost all of which is taxable at your income rather than long-term capital gains rate, you might end up with a $600 tax liability. Some funds practice tax-management which allows them to time or to pair sales in order to negate taxable gains, but Mr. Auer’s system doesn’t have that flexibility. You can add all of the short-term gains to the cost-basis of your account, but you’ll need to be durn diligent with your paperwork. Or you’ll be sensible to stick it in a Roth.



• The strategy may become supply constrained. One problem with a highly-opportunistic, all-cap strategy is that there may be markets in which the greatest number of qualifying stocks is in the small, micro or ultra-small universe. While buying shares of a company with a $10 million market cap is easy in an individual account, it may become problematic in a $500 million fund. The managers believe that the problem is . . . well, manageable. By their calculation, their system could operate easily enough with $750 million - $1 billion in assets but the effects of very small stocks on the portfolio will, necessarily, be diluted.



• The strategy is not being executed by the guy who made it work before. The system was run for years by Bryan Auer, now 72 and an advisor to the fund. The day-to-day decisions are being made by Robert Auer who, up until mid-2007, was working for a different company and, presumably, using a different system. While parts of the system are purely mechanical (the three primary quantitative screens), it’s hard to know how well he’ll be able to execute the nine secondary screens since their nature is a proprietary secret.

Bottom Line: I’m deeply skeptical of results which are too good to be true. That being said, Mr. Auer’s performance has been consistently brilliant. Can it be translated to a mutual fund? That’s a d**ned fine question and I don’t, for the life of me, know whether the greater fool is the fellow who bets he can repeat this success or the fellow who bets he can’t. Perhaps you might consider following Mr. Auer’s lead: buy if you think its prospects are compelling (if speculative) and sell as soon as (if?) it doubles.