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Valuations are Key in this Fund

Steven Lehman, portfolio manager of the Federated Market Opportunity Fund thinks many stocks--and the markets--- are still overvalued. So where does this value-oriented P.M. invest the fund's assets? Currently, 26 percent of it is in cash.

Look inside the portfolio of Federated's Market Opportunity Fund, (FMAAX), and you'll find that cash is king. Last year. the fund's average holding of cash represented 25 percent of assets. This year, it's about 26 percent. One of the reasons for that high cash position is because Lehman thinks that the market is still expensive.

"I've been very cautious about the major market indices, particularly the S & P 500 and the NASDAQ, for several reasons. The most important is valuation," he says. "Stocks that are priced very expensively are a reflection of high expectations and leave no room for error."

As a result, Lehman---whos fund ended last year up 17.5 percent and this year is up about 0.3 percent--isn't expecting the market's to return much over the next few years. In fact, he says that the market is more expensive today than it was in the '20s, the '60s, the early '70s or 1987. "I think that Warren Buffet and John Templeton, two of the greatest investors in the last 100 years, are right in that the market will produce minimal or low single-digit returns for perhaps five, seven or even 10 years from here."

So where does this value manager look to find investmensts for the fund's assets ? With 90 holdings in its portfolio, a hefty portion of them are in real estate investment trusts, (REITs), and convertible securities.

Here's more from Lehman about the Federated Market Opportunity Fund:

Q: You've been managing this fund since its inception in late 2000 and have stayed away from tech stocks. Why?

Lehman:The tech sector today is as overvalued as it was two years ago.

Q: Even with the per share prices on some of those stocks really low?

Lehman: Oh, that means nothing because the earnings fundamentals have collapsed even more so than the companies. Take Intel, for example.Intel's annual revenues now are about what they were five years ago and yet the stock is three times more expensive based on earnings and revenues than it was then when it was in a business that was growing rapidly.

I think the tech sector is widely misunderstood by investors. It's not a growth sector. There is rapid inevitable product obsolescence that makes these products commodities; the businesses do not generate free cash flow; and the product cycle seems to be shorter now than it's ever been.

Q: Where are you investing the fund's assets and finding value within the market?

Lehman: We've got 26 percent in cash, 25 percent in REITs ---which I think are as misunderstood as tech stocks are. People seem to over value stocks and under appreciate REITs because of their recollections of the real estate partnership schemes from the 1970's and 1980's. But many of the publicly traded REITs are well managed. One of the fund's holdings is Pan Pacific. It's an operator of community shopping centers that generally have grocery store super markets in them.

I have about 10-15 percent in utilities and have been buying convertibles of Teco Energy. It's out of favor at the moment and the convertible yields 9.5 percent. About 10 percent of the fund's assets are invested in the energy group. Imperial Oil, a Canadian company, is one my favorite holding in that group.

There is nothing in technology. And, nothing in banks because I think the consumer is stretched financially and that credit risks are rising at banks.

Q: What size companies do you invest in and what's the fund's benchmark.

Lehman: The benchmark is the Russell Mid-Cap Value index. And we're classified as mid-cap value fund by Lipper and Morningstar. But the fund really has no capitalization restrictions. There are small-caps, large caps, band the bulk of the holdings are in mid-caps because that's where I've found the best values.


Dian Vujovich is a nationally syndicated mutual fund columnist, author of a number of books including Straight Talk About Mutual Funds (McGraw-Hill), and publisher of this web site.

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