Recession-Proof Investing

Holland Capital’s Monica Walker repositions her portfolio to weather economic turmoil

Portfolio managers are human too. They feel pressures. They worry about results. So when there’s a sense that the country is on the path to a recession, they move rapidly to make adjustments and protect their positions. Over the past 16 months, Monica Walker, president and chief investment officer of equity at Chicago’s Holland Capital Management (No. 9 on the BE ASSET MANAGERS list with $2.2 billion in assets under management), has made that daunting task her primary focus.

As the full impact of the subprime mortgage crisis unfolded throughout 2007, Walker and her team got to work. For example, they compressed the firm’s exposure to financial stocks to 9%, down from some 20%.

Walker’s strategies led the firm’s Lou Holland Growth fund (LHGFX) to a 9.4% total return in 2007 compared with 5.5% for the S&P 500. As of early February, the fund had a five-year average annualized return of 8.6%. Walker says her firm typically angles for companies that are projected to boost earnings by 10% or more a year. At the same time, the house rule of thumb is to sidestep stocks whose price-to-earnings multiple is more than 1.5 times their projected earnings growth rate—referred to as a stock’s PEG ratio or price-to-growth ratio.

Just how bad do you think an economic downturn will be?
We should continue to see volatility in 2008, at least for the first two quarters. One of the biggest threats to stock market returns is the risk of recession, something that has increased as last year’s credit crisis has intensified and a slowdown in consumer-related spending has taken hold. In January we saw unemployment and payroll numbers decline for the first time since August 2003. It’s one thing that the banks are having problems. It’s now apparent that consumers are also being affected.

What steps are you taking to batten down the hatches?
Even in a recession, we’re conservative growth managers, so we look for companies with double-digit earnings growth potential and that are selling at decent valuations. We think our style does better than more aggressive styles of growth investing during a recession.

Are there still good values in the financial sector?
We went about reducing our weighting in financial stocks in order to get out of names that were exposed to mortgages. We have owned the insurer AFLAC (AFL) for a long time and continue to do so. It has virtually no exposure to the mortgage and credit crunch. The company is a supplemental insurance provider that does business in the U.S. and Japan. In the near term, AFLAC will get a big boost from deals to open new distribution channels in Japan, including a contract to potentially sell insurance through its 24,000 post office branches. We see AFLAC growing earnings at about 15% annually for the next three to five years, yet the stock carries a P/E of 17 times estimated 2008 earnings—making its PEG ratio just over 1.

Healthcare is a defensive position—what do you like in the group?
We purchased shares of the pharmaceutical outfit Schering-Plough

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