Quality Buffs Up Advance Capital Fund

When the stock market stumbles on bad times, it makes Don Peters happy.

The portfolio manager of the Advance Capital I Equity Growth Fund figures the market's struggles make his fund look better than others. That's because he focuses on high-quality stocks with solid fundamentals. That might not be too sexy in periods when the market is putting more value on riskier stocks. But when quality is in favor, the fund hits its stride.

"We do best on a relative basis in tough markets," Peters said. "When the economy is roaring and the market is doing well, we get our doors blown off. We really get paid in down markets."

The idea is to limit risk. So as the market hit a speed bump this year, it played into the fund's hands.

"Since the end of the second quarter, the market is less risk-seeking and more risk-averse," Peters said. "People are investing in better companies."

Peters works for T. Rowe Price, his employer since 1993 and which Advance Capital hired as subadviser. He combines some quantitative screens with fundamentals to figure out which stocks to buy.

"The primary thing we're looking for is good businesses," he said.

That means firms that have a long-term competitive edge, healthy earnings and sales growth, strong free cash flow and solid management.

Peters hunts for companies that boast earnings growth of at least 15%. But that's not a set limit.

He owns the likes of Wrigley (NYSE: - ) and Hershey (NYSE: - ), which averaged less than 10% profit growth the past three years. "But they're such terrific businesses, they're worth owning," Peters said.

On the flip side, Peters looks to sell any stock whose positive traits turn negative. If cash flow slows or the competitive edge dwindles, he'll dump it.

Not Too Big

Size plays a part, too. If a stock gets too big, Peters will sell it.

He stays in the mid-cap range. He'll consider anything with at least $1.5 billion in market cap, and he'll start selling a stock that reaches the upper limits of the Russell Midcap Growth index. That's about $20 billion now.

Peters seeks companies with cheap or reasonable valuations, based on price-earnings ratio compared with the market. If those gauges get too high, he'll think about selling.

His moves have paid off. The fund gained 9.25% this year going into Tuesday vs. 9.73% for mid-cap growth funds tracked by Morningstar and 3.46% for the S&P 500.

For the 10 years ended July 31, the fund cranked out an average annual return of 10.01% vs. 7.66% for its peers and 4.98%.

Peters holds stocks longer than most. He's patient enough to buy a stock with good fundamentals and wait for that to show up in its stock price. The portfolio averages yearly turnover of about 30%. The typical growth fund would top 100%.

"It's really important to be disciplined and to have a sound strategy," he said.

Valuation relative to the market plays a big part in his sector moves. Energy and materials have been the top sectors over the past five years. He is underweight in both of those now.

Technology and health care have been among the worst. That's where he has more exposure than the market. The fund recently increased exposure to financials, another area of recent weakness.

Nymex (NYSE: - ), an options exchange operator, features an IBD Composite Rating of 89, though its price performance has been weak.

"I see that as a great opportunity over the long term," Peters said. "Volatility is very good for options exchanges."

Metal parts manufacturer Precision Castparts (NYSE: - ), the fund's largest holding as of June 30, has gained 122% in the past year. It boasts an IBD Composite Rating of 99. But the stock has surged so much that Peters is trimming it.

Republic Services (NYSE: - ), a newer buy with an IBD Composite Rating of 85, is relatively cheap and has strong management, Peters says.

"That company could be attractive for several years," he said.