Success Happy

The mad genius of mutual funds

Summary: Ken Heebner is a maverick manager with an amazing history of making big winning bets on stocks and sectors By Jon Birger FORTUNE senior writerJune 15 2006 12 54 PM EDTNEW YORK FORTUNE What does it take to be an investing genius For starters you ve got to have the guts to go against the herd And that s a quality Ken Heebner of CGM Funds displayed as far back as college As an undergrad at Amherst in the early 1960s Heebner participated in a psychology class experiment that was supposed to demonstrate how easily people can be swayed by the views of others Heebner was asked for his impression of a painting and then ushered to another room where an expert offered an opposing viewpoint Then Heebner was asked once again what he thought of the painting Says Heebner They told me afterward that I was the only one who showed no evidence that other people s opinions had any effect whatsoever on what I thought That independent streak has helped make Heebner one of the most successful and original investors of his time In an era when most fund managers seem more concerned with beating indexes than beating paths to glory Heebner isn t afraid to follow his instincts He makes big bets on companies and sectors pulls the plug quickly when conditions change and dares to short blue chips like Dell Charts or Wal Mart Charts that he deems overvalued When Heebner is wrong he ll grossly underperform the market though outright yearly losses at CGM Realty and CGM Focus his biggest funds have been rare But when he s right the gains are astronomical CGM funds aren t for everyone especially investors who crave predictability Morningstar the fund research firm goes so far as to label his style too gutsy to be practical although that strikes us as unfair Gutsiness has always been integral to investing greatness And there s no question Heebner is one of the all time greats Today he manages $6 6 billion most of it in four CGM mutual funds his flagship Capital Development now closed to new investors Focus Realty and Mutual which holds a mix of stocks and bonds Realty has the best three year five year and 10 year returns in its Morningstar peer group Focus has returned 30 5 percent annually over the past three years And while Legg Mason s Bill Miller may be the fund world s brightest star Heebner s Capital Development fund has actually outpaced Miller s Value fund since the latter debuted in 1982 Going back further in the 30 years since Heebner took over the fund in 1976 Capital Development has trounced the S 500 gaining an average of 17 2 percent a year vs 12 8 percent for the index Best of all Heebner is getting better with age His last six years have been stellar as well as redemptive coming on the heels of the late 90s bull market that flummoxed the tech averse Heebner Focus his biggest fund returned just 3 5 percent in 1998 vs 28 6 percent for Standard Poor s 500 Realty lost 21 2 percent that year But he s been on a roll since 2000 with a series of remarkably prescient calls In 2000 he made a bundle short selling tech and telecom stocks In 2001 he made a huge and hugely profitable bet on homebuilder stocks which soared over the next three years Yet despite the fact that he became a vocal cheerleader for the sector he never fell in love with his winners as so many investors do Just as the housing boom neared its peak he grew worried about the proliferation of what he termed funny money mortgages Heebner ruthlessly unloaded every homebuilder share he owned by early 2005 and plowed the proceeds into energy stocks even in the Realty fund right before oil prices took off Then in late 2005 he doubled down on commodities with a big bet on copper the price of which has risen 67 percent year to date Ken is one of the best big picture thinkers I ve known says his friend Chuck Clough the former Merill Lynch Charts chief investment strategist He does the research and he s got the courage of his convictions FORTUNE senior writer Jon Birger recently caught up with Heebner for a wide ranging talk on the stock market the art of investing his aversion to vacations and why at age 65 he has no plans to retire Your investment style is quirky How do you define it I ve never done a good job answering that question and that s probably why there are people better at selling themselves than I am I ve made the most money when my strategy was something few people agreed with My huge outperformance occurs when I find one of these very contrarian strategies something supported by a lot of deep analysis and implement it in a concentrated way in the portfolio Like investing in oil in 2004 when everyone thought it was going back to $25 a barrel Or buying savings and loans in 1982 back when interest rates were 15 percent I wish I could find one every year but I can t CGM funds aren t real popular with 401 k plans or pension consultants According to Schwab only one of the 750 401 k plans it administers offers CGM funds Does this bother you People get scared when they see how my returns vary The consultants don t want you straying that far from the benchmarks That s a problem for me because I don t pay attention to benchmarks Are you surprised your bet on copper has paid off so well It s gone up more than I thought it would but there s a real supply demand imbalance Copper goes into the infrastructure of all developing nations of which India and China are the most publicized but not the only ones Copper production hasn t been able to grow fast enough to keep pace with demand When you look around the world today the earliest we can see incremental new production coming online is 2009 or 2010 Now one of the things that usually happens when the price of a commodity rises like this is you get demand destruction But in the case of copper 75 percent of its use is for wiring and there aren t good substitutes Aluminum and silver have superior conductivity but silver is much too expensive and aluminum isn t practical because it s bulky So you re not seeing demand destruction in copper and when you don t have demand destruction prices keep going up So you re sticking with your copper stocks like Phelps Dodge Charts and Southern Copper Charts I look at the prevailing expectations There is nobody I know of who s forecasting that the price is going to stay this high $3 54 a pound in early June The consensus estimates are for a sharp decline down to around $1 50 a pound Which you actually see as bullish Yes It encourages me because I have reasons why I think it won t go down That said I don t have same level of conviction as I did last year When we discussed copper last fall you clearly knew a lot more about the supply outlook than most commodity analysts Copper production is water intensive and you mentioned water has been in increasingly short supply in some mining regions in Chile the world s leading producer Where do you get such good info Even today no one else is interested in the water issue in Chile You call the companies up and they tell you there s no problem the reason is they re trying to buy water rights and don t want to lose leverage So if all you do is talk to management you re going to hear there s no problem But I talked to a mining engineer from one of the companies operating in Chile and he started out saying We don t have a water problem we get 700 liters per second from our mine in the southern part of the country But then he mentioned how those guys up north they get only four or five liters per second I go Really He says Yeah they have to go 200 kilometers to get water Was it that way two years ago No One of your colleagues told me you read a lot of obscure trade publications like China Metals Weekly It s all about looking for an investable advantage Given the interest in China you d think that a publication that reported prices in China every week in five different regions would be on everybody s reading list at least if you re interested in commodities But it wasn t I d be talking to a steel analyst and he d say the price of steel in China was X and I knew it was Y I knew the price of steel in China was going up a lot which is why I was in steel stocks My judgment is that the Chinese price is the swing price in the global steel market You don t usually invest in technology yet you have a sizable position in chipmaker Advanced Micro Devices Why With AMD Charts you ve got a company that for most of the past 20 years seemed to exist only because Intel felt it needed a competitor rather than face the Justice Department But new management has come in and AMD now is ahead of Intel in terms of providing the architecture that users want as well as chips that use less power which is why they re gaining share at a pretty rapid rate Why are your forays into tech so rare It s a business where change is very rapid Even if you identify a competitive advantage it can disappear quickly Also what I look for when I m investing is some piece of data that I can use to monitor what s going on If it s a retailer it s same store sales If it s a commodities producer it s the price of the commodity The numbers are murkier with technology companies Did you learn anything from the late 90s The people who did the best during that period were those who bought overvalued stocks held them till they were obscenely overvalued and sold before they collapsed I don t know how to do that I need some sort of framework where I can say the valuation is this and if the earnings do that the stock will be strong My big mistake was that I decided to try to keep clients happy by staying with the trend I bought some of the stocks like Cisco I thought the stocks were overvalued but I bought them anyway to try to have better performance What happened is that I w Ken Heebner is a maverick manager with an amazing history of making big winning bets on stocks and sectors By Jon Birger FORTUNE senior writerJune 15 2006 12 54 PM EDTNEW YORK FORTUNE What does it take to be an investing genius For starters you ve got to have the guts to go against the herd And that s a quality Ken Heebner of CGM Funds displayed as far back as college As an undergrad at Amherst in the early 1960s Heebner participated in a psychology class experiment that was supposed to demonstrate how easily people can be swayed by the views of others Heebner was asked for his impression of a painting and then ushered to another room where an expert offered an opposing viewpoint Then Heebner was asked once again what he thought of the painting Says Heebner They told me afterward that I was the only one who showed no evidence that other people s opinions had any effect whatsoever on what I thought That independent streak has helped make Heebner one of the most successful and original investors of his time In an era when most fund managers seem more concerned with beating indexes than beating paths to glory Heebner isn t afraid to follow his instincts He makes big bets on companies and sectors pulls the plug quickly when conditions change and dares to short blue chips like Dell Charts or Wal Mart Charts that he deems overvalued When Heebner is wrong he ll grossly underperform the market though outright yearly losses at CGM Realty and CGM Focus his biggest funds have been rare But when he s right the gains are astronomical CGM funds aren t for everyone especially investors who crave predictability Morningstar the fund research firm goes so far as to label his style too gutsy to be practical although that strikes us as unfair Gutsiness has always been integral to investing greatness And there s no question Heebner is one of the all time greats Today he manages $6 6 billion most of it in four CGM mutual funds his flagship Capital Development now closed to new investors Focus Realty and Mutual which holds a mix of stocks and bonds Realty has the best three year five year and 10 year returns in its Morningstar peer group Focus has returned 30 5 percent annually over the past three years And while Legg Mason s Bill Miller may be the fund world s brightest star Heebner s Capital Development fund has actually outpaced Miller s Value fund since the latter debuted in 1982 Going back further in the 30 years since Heebner took over the fund in 1976 Capital Development has trounced the S 500 gaining an average of 17 2 percent a year vs 12 8 percent for the index Best of all Heebner is getting better with age His last six years have been stellar as well as redemptive coming on the heels of the late 90s bull market that flummoxed the tech averse Heebner Focus his biggest fund returned just 3 5 percent in 1998 vs 28 6 percent for Standard Poor s 500 Realty lost 21 2 percent that year But he s been on a roll since 2000 with a series of remarkably prescient calls In 2000 he made a bundle short selling tech and telecom stocks In 2001 he made a huge and hugely profitable bet on homebuilder stocks which soared over the next three years Yet despite the fact that he became a vocal cheerleader for the sector he never fell in love with his winners as so many investors do Just as the housing boom neared its peak he grew worried about the proliferation of what he termed funny money mortgages Heebner ruthlessly unloaded every homebuilder share he owned by early 2005 and plowed the proceeds into energy stocks even in the Realty fund right before oil prices took off Then in late 2005 he doubled down on commodities with a big bet on copper the price of which has risen 67 percent year to date Ken is one of the best big picture thinkers I ve known says his friend Chuck Clough the former Merill Lynch Charts chief investment strategist He does the research and he s got the courage of his convictions FORTUNE senior writer Jon Birger recently caught up with Heebner for a wide ranging talk on the stock market the art of investing his aversion to vacations and why at age 65 he has no plans to retire Your investment style is quirky How do you define it I ve never done a good job answering that question and that s probably why there are people better at selling themselves than I am I ve made the most money when my strategy was something few people agreed with My huge outperformance occurs when I find one of these very contrarian strategies something supported by a lot of deep analysis and implement it in a concentrated way in the portfolio Like investing in oil in 2004 when everyone thought it was going back to $25 a barrel Or buying savings and loans in 1982 back when interest rates were 15 percent I wish I could find one every year but I can t CGM funds aren t real popular with 401 k plans or pension consultants According to Schwab only one of the 750 401 k plans it administers offers CGM funds Does this bother you People get scared when they see how my returns vary The consultants don t want you straying that far from the benchmarks That s a problem for me because I don t pay attention to benchmarks Are you surprised your bet on copper has paid off so well It s gone up more than I thought it would but there s a real supply demand imbalance Copper goes into the infrastructure of all developing nations of which India and China are the most publicized but not the only ones Copper production hasn t been able to grow fast enough to keep pace with demand When you look around the world today the earliest we can see incremental new production coming online is 2009 or 2010 Now one of the things that usually happens when the price of a commodity rises like this is you get demand destruction But in the case of copper 75 percent of its use is for wiring and there aren t good substitutes Aluminum and silver have superior conductivity but silver is much too expensive and aluminum isn t practical because it s bulky So you re not seeing demand destruction in copper and when you don t have demand destruction prices keep going up So you re sticking with your copper stocks like Phelps Dodge Charts and Southern Copper Charts I look at the prevailing expectations There is nobody I know of who s forecasting that the price is going to stay this high $3 54 a pound in early June The consensus estimates are for a sharp decline down to around $1 50 a pound Which you actually see as bullish Yes It encourages me because I have reasons why I think it won t go down That said I don t have same level of conviction as I did last year When we discussed copper last fall you clearly knew a lot more about the supply outlook than most commodity analysts Copper production is water intensive and you mentioned water has been in increasingly short supply in some mining regions in Chile the world s leading producer Where do you get such good info Even today no one else is interested in the water issue in Chile You call the companies up and they tell you there s no problem the reason is they re trying to buy water rights and don t want to lose leverage So if all you do is talk to management you re going to hear there s no problem But I talked to a mining engineer from one of the companies operating in Chile and he started out saying We don t have a water problem we get 700 liters per second from our mine in the southern part of the country But then he mentioned how those guys up north they get only four or five liters per second I go Really He says Yeah they have to go 200 kilometers to get water Was it that way two years ago No One of your colleagues told me you read a lot of obscure trade publications like China Metals Weekly It s all about looking for an investable advantage Given the interest in China you d think that a publication that reported prices in China every week in five different regions would be on everybody s reading list at least if you re interested in commodities But it wasn t I d be talking to a steel analyst and he d say the price of steel in China was X and I knew it was Y I knew the price of steel in China was going up a lot which is why I was in steel stocks My judgment is that the Chinese price is the swing price in the global steel market You don t usually invest in technology yet you have a sizable position in chipmaker Advanced Micro Devices Why With AMD Charts you ve got a company that for most of the past 20 years seemed to exist only because Intel felt it needed a competitor rather than face the Justice Department But new management has come in and AMD now is ahead of Intel in terms of providing the architecture that users want as well as chips that use less power which is why they re gaining share at a pretty rapid rate Why are your forays into tech so rare It s a business where change is very rapid Even if you identify a competitive advantage it can disappear quickly Also what I look for when I m investing is some piece of data that I can use to monitor what s going on If it s a retailer it s same store sales If it s a commodities producer it s the price of the commodity The numbers are murkier with technology companies Did you learn anything from the late 90s The people who did the best during that period were those who bought overvalued stocks held them till they were obscenely overvalued and sold before they collapsed I don t know how to do that I need some sort of framework where I can say the valuation is this and if the earnings do that the stock will be strong My big mistake was that I decided to try to keep clients happy by staying with the trend I bought some of the stocks like Cisco I thought the stocks were overvalued but I bought them anyway to try to have better performance What happened is that I w

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