Fund name: Industry Leaders fund (ILFIX)

Objective: The fund seeks long-term capital appreciation through use of the Industry Leaders® Portfolio Strategy, a patented equity portfolio process (US Patent No. 7,107,229 B1).

Adviser: Claremont Investment Partners, LLC. Claremont was founded in 1996, advises this fund and handles about $5 million in separate accounts.

Manager: Gerald P. (Gerry) Sullivan. Mr. Sullivan is President of Claremont Investment Partners and a portfolio manager. Before that, he was a Senior Management Analyst for The Atlanta Committee for the Olympic Games, a bond options trader for O’Connor & Associates and a financial analyst for Salomon Brothers Inc.

Inception: March 17, 1999.

Minimum investment: $5,000 for regular accounts, $3000 for IRAs.

Expense ratio: 0.79% on an asset base of about $15 million. Hmmm . . . that means the management company takes home a cool $118,000 to cover salaries and all of the fund’s operating expenses. Which is to say, they seem to be running a tight ship. And there are two other share classes with lower expenses.

Comments: Well, normally I’d say that this fund was marketed as "smarter than the average mutual fund." Except that it isn’t. Well, it may be STTAMF – that’s the fund’s motto – but it does no marketing. It has a tiny group of investors, almost all of whom are literally family and friends of the manager, Gerry Sullivan. Nonetheless, its performance has been anything but tiny. All three share classes of the Industry Leaders fund have made it to FundAlarm’s Honor Roll. It’s a Lipper Leader among large core funds for Total and Consistent Returns, Capital Preservation and Expenses. And, according to the fund’s website, they are:

• The #1 large-cap blue chip fund over the past five years, by Bloomberg’s ranking
• In the top 10% of large-blend funds over the past five years, by Morningstar’s ranking
• In the top 4% of large-core funds over the past year years, by Lipper’s rankings.

The fund tends to hold its own in up markets and outperform the S&P by 2:1 in down markets. Morningstar currently ranks it as a four-star fund though its recent performance, top 5% YTD, may be enough to bump it up in the near future.

So, two questions:

1. Why does it make so much money?

and

2. Why doesn’t anyone invest in it?

Apparently it makes money because of its patented investment system. Really. The patent, for an "Apparatus and method for creating and managing a financial instrument," was issued on September 12^th of 2006 (I went and looked it up, just to be sure). Here’s what the Patent Office says it does:

Uh-huh. I called the manager, Gerry Sullivan. He comes across as a very bright, thoughtful guy who came up with a good idea and couldn’t convince anyone in the fund industry that it was worth a look, and so he built a fund himself. The fund qualifies as a quant offering, in which the patented system keeps the humans from second-guessing. There appear to be two elements to the investment plan: (1) invest only in industry leading companies which have strong balance sheets and (2) invest broadly.

The manager uses Value Line’s industries list and looks to see if each industry has a clear cut leader. If an industry group has no clear leader, he invests nothing in that group (paper & forest products, railroads and utilities are examples of leaderless groups). If there’s one clear leader and the leader has a clean balance sheet (reflected in a required high credit rating), he invests in it. If there are two companies vying for leadership (a duopoly) and both have clean balance sheets, he splits his investment between both. Typically about half of the portfolio is invested in single-leader industries and about half in duopolies.

Typically he has 70 stocks spread over 50 industries. No stock can exceed 2.5% of the total portfolio. The portfolio rebalances monthly to maintain that standard. Direct international exposure is minimal.

Apparently the combination of high quality companies and assiduous rebalancing works. In addition to the fund’s success, the "historical performance analysis" shows that over the past sixteen years, the industry leaders strategy has substantially outperformed 10 of 11 possible benchmarks including the S&P, the Naz, the Dow, Value Line Arithmetic, the Russell 3000 and others. The only benchmark with a stronger long-term record is the Russell 2000 Value which beats this strategy by less than 0.5% per year.

So why doesn’t anyone invest in it? Because it’s hard to market a tiny fund ("a blue chip fund run by some guy out in Joisey?") and Mr. Sullivan made a conscious choice not to market the fund. As someone who was not a fund professional, he was loathe to encourage strangers to entrust their money with him until he was pretty durn sure that he could be trusted with it. And so he wanted to get five years’ worth of performance experience. But at about the five year mark he tweaked the portfolio process and thought it would be prudent to watch a bit longer. He has now concluded that he’s right . . . the process works and the fund really is a viable option for folks beyond his family (his daughters both work with and invest in the fund) and friends. It should be available soon through Fido, Schwab and TD Ameritrade.

Concerns? Two come to mind. First, there might be a substantial inflow of capital in a very short period. When you are used to investing tiny sums, even one really rich guy can greatly change the equation. That concern is obviated by the fact that the fund invests in huge, liquid stocks and its turnover is limited. Second, the enforced monthly rebalancing might goof with the fund’s tax efficiency. Mr. Sullivan hesitated to recommend the fund for taxable accounts, but Morningstar says that it loses less than a percent a year to taxes. And if there are substantial net inflows, turnover will drop – instead of selling appreciated names to re-establish the portfolio balance, the manager will be able to simply buy more of the other stocks in the portfolio to achieve the same effect.

This might be an especially good time to consider a fund devoted to high-quality equities, given the market's incredible (perhaps unsustainable) optimism of late and GMO's projection that high-quality US equity will outperform all other asset classes over the next seven years.

Bottom line: The Industry Leaders fund is a more-or-less classic case of a "star in the shadow." A good idea with an intentionally low profile, a small but dedicated set of investors and consistently strong returns. Gerry Sullivan and his folks deserve both more attention and some considerable admiration for their work.

Company link: Industry Leaders Fund



December 1, 2006