Taking the Helm at Clipper
Chris Davis on how he'll steer the stock fund--and what he thinks of Costco and Google.
by Julie Schlosser

(FORTUNE Magazine) - When James Gipson and his team announced their departure from the Clipper Fund in late September, many observers assumed that their replacements would come from inside the fund's parent company, Old Mutual. But in November, Clipper's board of directors surprised the industry by hiring outsiders. Their picks? Christopher Davis, a rising star who oversees $45 billion in mutual fund assets for his firm, Davis Selected Advisers, and his partner Kenneth Feinberg. The pair, who were just named Morningstar's domestic stock managers of the year, took over the $4 billion fund on Jan. 1. They have big shoes to fill. Under Gipson, Clipper produced 15% annualized returns for more than 20 years. Gipson was famous for holding cash--up to 45% of fund assets--when he couldn't find stocks he liked. FORTUNE's Julie Schlosser chatted with Davis, 40, about his new assignment.

The Davis funds and Clipper have several big stocks in common, including Altria, American Express, and Tyco. How will your approach differ from Gipson's?

We have a similar opportunistic approach, a similar tendency toward concentration, but the way that gets implemented toward specific companies--that will never be the same. There are a lot of companies he owns that we don't own.

Your predecessors often let cash build up when they couldn't find anything to buy. Will you?

I think that is the difference. Ken and I have typically not held as much cash. It is not that we need to fully invest; we've had cash drift up to double digits. If we can't find things to buy, we usually like adding to what we own. I think it is likely that we will have cash from time to time. It will not reflect a view of the market but will reflect an inability to find an opportunity at that moment. It is a residual, not a strategy.

Will the fund look very different under you?

I think that even during the transition from Jim's management to ours, it is very likely that the portfolio turnover will be still substantially less than the average annual turnover in the average mutual fund. That's kind of shocking.

You and Ken have been known for getting out of companies where you believe the executives are overpaid. Is that a matter of principle or strategy?

We have no problem with exorbitant pay so long as it is tied to exorbitant performance. The real crisis in executive compensation is pay for mediocrity. When we make an investment, our intent is to own it for a long time. Our turnover last year was around 6% to 7%. That implies a ten- or 15-year holding period. The character of your partner--the management of the company you are investing in--is going to be a huge determinant of your return over time. We are going to look for clues or insight into the character of management. The proxy statement is a hell of a good place to start. How do they pay themselves? What are the hurdles over which they must leap to earn incentive compensation? Do they have to do better than their peer group? Better than the S&P? Do they simply have to have a pulse?

The Davis funds hold Costco shares, and Clipper currently holds Wal-Mart. Where do you come down on the Wal-Mart vs. Costco debate?

We love Costco. Costco serves a more upscale demographic, using a membership model and offering a limited number of products. The way they treat employees and the value they give clients makes them a wonderful, wonderful company. That said, Wal-Mart's shares are priced lower than Costco's. And I think that Wal-Mart has plans for meaningful square-footage growth, even in this country.

Nearly 5% of Clipper's assets are in Altria Group. After a recent court victory, the stock hit an all-time high. Does it have room to run?

The funny thing about Altria is that when it was at $20 a share, it was so terrifying that you didn't want to talk about it. Altria has been an incredible stock for 30 years. Yes, it has had a big move as the legal environment has improved. But compared with other consumer products companies, it doesn't seem overvalued, especially considering its substantial dividend yield.

You often say that you like the price pessimism produces. Where do you see clouds forming ?

There's a lot more pessimism today than there was in 1998. Stocks are at the same prices, but earnings are 75% higher. Some of the best companies are trading at a discount to the averages. It is the opposite of '98--'99. I think large, growing, global franchises look far more attractive today than at any time during my career. From Wal-Mart to Microsoft, it is amazing that you can be buying these types of companies at below-average valuations.

Are there any sectors you are avoiding?

We haven't owned the drugs, because we're concerned about litigation and patent expiration, among other things. We have worried about owning financial companies that are wildly exposed to the yield curve and have been playing games with interest rates.

The Davis funds own Berkshire Hathaway. Will you buy it for Clipper?

People seem to be coming to terms with the fact that Warren Buffett is not immortal. We were hoping otherwise. Berkshire is a holding company for a series of wonderful cash-producing businesses. You can look at its valuation in a bunch of different ways. I would say that Berkshire Hathaway could very comfortably pay a 5% dividend annually at today's level and still have enough cash available to reinvest in its businesses.

You don't own Google. Are you kicking yourself for not buying it?

Yes, although I am not kicking myself because it has gone up a lot, but because it came public at 14 times earnings. But nobody knew it was at 14 times earnings except maybe [Legg Mason manager] Bill Miller. I think the company was easy to dismiss. It had this funny name and sounded like a lot of hype. I think if we had looked deeper into the amount of value that Google creates for its customers, we would have understood its earnings power much better than we did. I have a share of it on my desk as we speak. We have a "mistake wall." Unfortunately it is turning into a mural. But we believe there is enormous value in studying your mistakes and trying to understand the lessons.

Do you have any investing resolutions for 2006?

No. But I would say the old lesson that has been reinforced over the past several years is the futility of short-term forecasts. When you look at what's happened in the past five to six years, in terms of stocks both going up and going down, the experts have been consistently and dramatically wrong. There's such enormous uncertainty out there that you need to try to focus on what can be known about the underlying company. Top of page

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