of bonds held in the portfolio as interest rates rise, and how much to over- or underweight sectors in the stock portfolio relative to the S&P 500. And Patrick Lee researches the companies in the stock fund. Brimage and Smalls work in the Pittsburgh office, and Lee works in Philadelphia.
Unlike other large mutual fund complexes, Lay, Sanders and the other key members of MDL’s team don’t have the time to perform site visits. Instead, much like the sophisticated individual investor, they rely on available technology-from using quantitative screens to participating in conference calls on earnings-to monitor their investments. They used this process to pick such stocks as Microsoft (Nasdaq: MSFT), General Electric (NYSE: GE) and Cisco Systems (Nasdaq: CSCO), three of their top holdings in the equity fund.
There are circumstances under which Lay and Sanders will dump a stock. Generally, it takes two consecutive quarters of earnings disappointments, a short-term drop in the stock’s price of as much as 15% on a given day or a fundamental company-specific event like a management change or underperforming product line before Lay and Sanders completely sell a holding.
For example, Lay, Sanders and the firm’s investment policy committee decided to drop Cendant (NYSE: CD) last year. The provider of consumer and business services was embroiled in an accounting scandal.
MDL also shed several regional bank stocks, among them Bank of New York (NYSE: BK) and Mellon Financial (NYSE: MEL), amid worries that rising interest rates would hurt financial shares and that those stocks in particular wouldn’t be as profitable as those of other, more diversified banks.
From time to time, other adjustments to the equity fund’s portfolio have to be made, as simple price appreciation in particular stocks increases the fund’s exposure to sectors, such as technology, that have become more volatile. Case in point: Sanders shaved his ownership in certain high-flying technology shares at the beginning of this year, reducing stakes in companies like Microsoft, to 4% from about 5.5%, Oracle (Nasdaq: ORCL), to 1.6% from 2.6%, and Cisco Systems, to 1.3% from 2.3%.
As for the Broad Market Fixed Income fund, the top-down process is used to determine which sectors to overweight or underweight, such as U.S. Treasuries, corporates, asset-backed and mortgage-backed securities. Then, in the bottom-up part of the process, individual securities are selected to construct the portfolio.
Recently, that’s meant staying with bonds maturing in seven to 10 years, and emphasizing off-the-run U.S. Treasuries, bonds that are closer to maturity than those issued this year, which are called current or on-the-run securities.
And in this climate of rising interest rates, the fund has added certain mortgage-backed securities that perform better when rates rise. Recently, Lay purchased bonds issued by the Government National Mortgage Association (GNMA), among them Ginnie Maes with a 6.5% coupon, and those of the Federal National Mortgage Association, specifically Fannie Maes with a 6.5% coupon.
For its institutional clients, the firm has set up equity and fixed-income portfolios similar to the holdings in its mutual funds, with some differences in how