August 9, 2012 / 6:31 PM / 5 years ago

Bretton Fund's one-man band outperforms its peers

NEW YORK (Reuters) - There’s a lot that fund manager Stephen Dodson doesn’t have.

A portfolio of assets that’s larger than the average NBA salary, for one. A team of analysts, for another. Or a track record long enough to attract financial advisers as investors.

But none of those have been obstacles for the San Francisco money manager. Dobson, with help from his team of college interns and freelancers, navigated his tiny $3.8 million Bretton Fund to post a 35.6 percent one-year return through Wednesday’s close, putting Bretton in the top 1 percent of 411 actively managed stock funds tracked by Morningstar.

Those returns catapulted the Bretton fund into elite company, including various Pimco funds and Fidelity’s Contrafund, which posted 25 percent returns. Over the same period, the broad Standard and Poor’s 500 index returned about 25 percent.

It’s too early to tell if it’s just a spate of beginner’s luck for the less than two year-old fund. Dodson credits his strategy of buying and holding a small handful of stocks for the outperformance. His portfolio consists of 16 companies at a time when the average actively managed stock fund holds 149 companies, according to Lipper. He won’t hold more than 20 companies even as his assets grow, he said.

It’s a high-risk, high-reward philosophy of fund management in which one or two holdings can meaningfully skewer the entire portfolio’s returns for both good and bad. For his part, Dodson acknowledges that he’s taking bigger chances than some of his peers, but he said that they are worth it.

“There’s no way to meaningfully outperform over long periods of time without taking a greater concentration risk. The key part is making concentrated bets when I think I have very little chance of permanent loss of capital,” he said.

Dodson, 34, has some history in the world of mutual funds despite his relative young age. His father, Jerry Dodson, founded San Francisco-based independent fund manager Parnassus Investments, which now has about $6 billion in assets under management.

After graduating from U.C. Berkeley, Stephen worked as an investment banker at Morgan Stanley and as an analyst at venture capital group Advent International before joining the family business.

He began at Parnassus in 2002, and spent six years workyou saying at the company in jobs ranging from compliance to accounting to portfolio management. He founded Bretton Capital Management in 2008, and launched Bretton Fund in 2010.

He now works out of an office in San Francisco’s Ferry Building, where he is the only full-time employee. For research, he turns to a rotating team of Berkeley interns and the occasional freelance financial analyst. His fund charges $1.50 per $100 invested, a fee level that Morningstar characterizes as high. It had a turnover of 13 percent last year and requires a minimum investment of $5,000.

When looking at stocks, he’s trying to identify companies that have “defensible” business models that are trading at a discount to what he thinks the business is worth, he said. For example, he has a stake in each of the three major railroads - CSX, Union Pacific, and Norfolk Southern - because it’s a play on economic growth with a high barrier to entry.

“If you and I wanted to create a trucking company we could go out tomorrow and be up and running. But if someone gave us a billion dollars to create a railroad company we couldn’t do it,” he said.

Dodson’s search for defensible business models can lead him to industries that at first glance look too competitive for his strategy. Ross Stores, for instance, currently makes up 11.4 percent of the fund and operates in the notoriously fickle clothing market. Yet Dodson likes the chain because it buys excess inventory from retailers like Calvin Klein and sells them for up to 60 percent off in its stores.

“It’s a system that requires the scale to go to Calvin Klein and say, ‘We’ll take all of these lime green shirts and pay in cash and you only need to make one shipment,” he said.

His positions in Ross Stores and Gap Inc, which makes up 10.9 percent of the portfolio, were the largest contributors to the fund’s outperformance this year, he said.

Shares of Ross Stores are up 44 percent since the start of the year, and trade at a price to earnings ratio of 22.4. Shares of Gap Inc are up 87 percent for the year to date, and trade at a price to earnings ratio of 21. But with little further upside seen, Gap is a likely candidate to be cut, he said.

Dodson also is interested in companies that are unloved like Wells Fargo or JPMorgan Chase. Despite JPMorgan’s recent problems off-setting risk and needing to restate its earnings and Wells Fargo’s litigation and mortgage buyback woes, he calls them both banks “wonderfully run.”

Investors are overlooking the amount of income from fees and asset management that each company is generating, he said.

Not all of his picks turn out to be winners. Shares of fund holding Apollo Group, which still make up 2.8 percent of its holdings, have tumbled nearly 48 percent this year as the for-profit education company struggles with charges that it has misused government funds.

For all of his faith in his ability to pick stocks, Dodson does say that there are certain sectors of the market that he won’t touch. He said it’s too hard for investors to know what the media industry will look like in ten years, for instance. Biotech stocks are another bet that’s too risky for him.

“I don’t think an outside investor has any ability to predict which drugs will get FDA approval, even if they are an incredibly smart scientist,” he said.

Editing by Walden Siew and Leslie Gevirtz

Our Standards:The Thomson Reuters Trust Principles.
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