Equity markets have been generally flat this year and PRIMECAP (VPMCX) has been no exception, with a small gain of 1.25 percent through July 10. The fund is closed to new investors, but it remains a great core holding for investors who already hold it in their portfolios. With certain funds, such as health care, rising double digits in the first half, some investors with overweightings in that sector should consider rebalancing assets back to core holdings such as VPMCX or VIG.
The five-star Morningstar rated VPMCX seeks long-term capital appreciation and invests primarily in large- and mid-cap stocks that the managers believe have an above-average earnings growth potential not reflected by their current stock price. The fund has the flexibility to invest across all market segments and capitalizations. VPMCX may also invest up to 25 percent of assets in foreign issues. PRIMECAP Management Company, the fund advisor, utilizes an investment approach in which multiple managers each oversee a portion of the portfolio. Established in 1984, the fund continues to use this well-established investment strategy to manage more than $46 billion in assets.
Investment Strategy
VPMCX is led by an experienced team that includes co-founder Theo Kolokotrones. The management team also includes co-managers Joel Fried, Al Mordecai, M. Mohsin Ansari and James Marchetti. Each portfolio manager runs his own sleeve independently with the assistance of the firm’s 13 analysts. As managers and analysts prove themselves to be strong stock pickers, they receive larger portions of the fund to invest. This approach avoids groupthink and ensures a diversified portfolio. The fund may have a tilt toward certain industries and sectors as more than one manager may find them attractive, such as the current concentration in pharmaceuticals, biotech and information technology shares. Managers have aligned their interests with those of investors by having substantial personal investments in the fund.
Fund managers use what has been described as a patient contrarian growth approach to stock selection. Managers look for companies that have demonstrated rapid growth in the past and have the potential for continued future growth but have temporarily fallen out of favor. They are willing to wait for the stocks to rebound, as long as the underlying fundamentals remain unchanged. Managers anticipate holding shares for at least three to five years. The result is a low turnover rate, which is typically around 10 percent compared to the annual category average of 60 percent. Shares are generally sold when valuation targets are reached or there has been a significant change in the underlying fundamentals. There is no standard method for valuing stocks. Each holding or potential addition is evaluated on a case-by-case basis using independent research and a variety of analytical tools. The fund does not have an explicit market-cap limit as to which shares can be purchased.
Portfolio Construction and Holdings
This large-growth category fund holds 124 individual issues with a median market cap of $63.3 billion. It is allocated 83.65 percent in domestic shares, 11.2 percent in foreign stocks and 5.15 percent in cash. Foreign shares are concentrated in companies headquartered in Developed Europe. VPMCX has a giant-cap weighting of 50.88 percent and a large-cap allocation of 42.03 percent. It has a mid-cap exposure of 6.51 percent, which is significantly less than the category average of 17.84 percent. With 93 percent of holdings in large- and mega-cap shares, the fund is overweight these big cap stocks compared to the category average of 81 percent.
The fund’s top 10 holdings comprise 41.43 percent of assets under management. In descending order they are Biogen, Amgen, Eli Lilly, Texas Instruments and Microsoft followed by Roche Holdings, Adobe Systems, FedEx, Google and Novartis. VPMCX is underweight consumer staples, energy and financials. The portfolio has a P/E ratio of 21.4 and a price-to-book ratio of 4.0. The fund has a 19.6 percent average return on equity.
Performance, Risks, Fees and Distributions
With its high-quality portfolio, VPMCX held up during the 2008 market crash. It performed well in 2013 and 2014 as health care and tech shares dominated the market. After its managers were named Domestic-Stock Fund Managers of the Year by Morningstar for their impressive numbers for 2014, the fund has dropped from the top 1 percent to the bottom quartile as of mid-year 2015. The fund’s holdings in Southwest Airlines had a negative effect as airlines stocks have underperformed recently after a strong showing last year. Large-cap stocks have also underperformed the market this year, reflected in the small loss in the Dow Jones Industrial Average and small gain in the S&P 500 Index. The size of the fund also makes it difficult for VPMCX to own shares in some of the recent smaller high-flying biotech and information technology stocks. Despite the drop in the ranking, VPMCX still retains a Gold Morningstar analyst rating.
Boasting a high Morningstar return rating, VPMCX has average 1-, 3- and 5-year total returns of 7.32 percent, 22.17 percent and 19.07 percent respectively. These compare to the Large Growth category averages of 7.98 percent, 17.69 percent and 17.47 percent over the same periods. VPMCX has a below-average risk rating. The fund has a three-year beta and standard deviation of 0.92 and 8.58, which compare to the category averages of 1.00 and 16.14 respectively, making VPMCX much less volatile than the competition. Over the past three years, VPMCX has had an above category-average upside capture ratio of 106.22 and a below category-average downside capture ratio of 62.96. The fund has a 1-year trailing return of 14.6 percent and a 30-Day SEC Yield of 1.17 percent.
Vanguard funds often have the lowest fees in the industry. This large-cap no-load fund has an expense ratio of 0.44 percent, very low for an actively managed fund. The category average is 1.19 percent. On December 22, 2014, VPMCX had dividend, long-term and short-term distributions of $1.16, $5.667 and $0.041 per share with a reinvestment price of $104.39. Investors should be aware of the potential tax impact in December; if managers take profits on long-term holdings, there could be significant capital gains.
Outlook
The fund is currently overweight health care and technology. While it may demonstrate short-term volatility as it makes some concentrated investments, the overall strategy has produced strong long-term results. VPMCX is an excellent core holding in a well-diversified portfolio.