One on One: "Macros can come into play, but we as portfolio managers have our own views"

David Gilmore, 32, is one of the youngest portfolio managers at Federated Investors Inc.

Three years ago, Mr. Gilmore was put in charge of the Federated Capital Appreciation Fund, and he has been flying high ever since.

Peers note that Mr. Gilmore is unusually attentive to risk. He also knows how to think outside the box when it comes to making stock selections, they add.

Since hiring him almost straight out of business school, Pittsburgh-based Federated has learned that Mr. Gilmore is capable of thinking on his feet, so he is given fairly free rein in speaking to reporters.

“He doesn’t trim his sails to the prevailing wind,” says Brian E. Broadway, senior vice president of Chesapeake Capital Corp., a $1 billion hedge fund in Richmond, Va. “He’s not afraid to think, and he applies that in his personal and professional life,” adds Mr. Broadway, who previously worked with Mr. Gilmore at Coopers & Lybrand LLP.

Q Your fund’s performance has beaten its peers’ over the past five years. How did you build that track record?

A Two-thirds of that outperformance came from stock selection, and the other third came from sector allocation. It wasn’t a particular style or beta.

It also goes to the structure of our fund. Styles change leadership, and when that style changes, it can be pretty quick and violent.

As a core fund, it’s important to recognize and measure how much of each style is in your portfolio and maintain an equal balance of both. So we never let ourselves have more than 60[%] or less than 40[%] in either style.

So particularly in this five-year track record that’s seen a change in leadership from growth to value – growth in the first two years, value in the last three – that [balance] to some extent has helped us to weather the storm.

Q The mandate of your fund is very broad. Why have you chosen so many aircraft carriers, such as Wal-Mart Stores Inc. (WMT), Microsoft Corp. (MST), Exxon Mobil Corp. (XOM) and General Electric Co. (GE)?

A It’s fairly typical, because while the prospectus is fairly broad in what we can do, we do consider ourselves a large-cap-core fund in the domestic universe, competing against the S&P 500. So we want to do it on the same playground and in the same universe with those stocks. It’s pretty similar to what you’ll see in the future.

There’s one difference now versus what you may have seen a couple years ago. Our average market cap has crept up over time. A lot of our peers only look at stocks $10 billion and above. But since the S&P is made up of 15% mid-caps or smaller on an asset-weighted basis, and 60% or smaller on a names basis, we look at a larger universe of stock at $2 billion and above.

Looking back the past couple years, we had a smaller market cap than our peers because we were finding more opportunities in the $2 billion to $5 billion range.

Q Has this portfolio been too conservative this year, considering it has you trailing your peer funds, whereas you’ve outperformed them for the past five years?

A We are more conservative than our peers, and that’s probably why we’re lagging our peers in a year when the market is rallying.

We started getting more aggressive in the third quarter of last year. Unfortunately, we did not get aggressive enough.

We have been consistently more aggressive: third quarter, fourth quarter, first quarter, second quarter. The aggressive names started looking more attractive, not because the market started improving. Had we not made those moves, we’d be worse off than we are.

Q Among your sector choices, you mirror the category average in many cases, but you have fewer financial stocks. Why?

A The reason for that is not an explicit one. If we look throughout sectors and where sectors have traded relative to the rest of the market and where their earnings risks lie, they’re much more normalized now than they were even 12 months ago.

We’re not trying to be tied to the benchmark. We’re just noting there are not a lot of opportunities there as there were a few quarters ago, so you’re not really being paid to take that risk.

As to underweight in financials, it’s more of a valuation call than a sector call. When we look at these names versus the rest of the market, this is one area where valuation looks more stretched, so we’re finding fewer opportunities. We added to the sector at the end of the quarter because it got more attractive.

Q Citigroup Inc. (C) is your second-largest holding, and it is the best-performing stock in the portfolio. What do you think of it now?

A We almost doubled the position size in March after financials sold off, and it was selling at a pretty unbelievable multiple at the time. Its valuation relative to the market is still reasonably attractive.

It should be a good beneficiary of improving credit trends and improving equity markets.

So the earnings are still underestimated for Citigroup, and so the valuation is more reasonable than it looks.

Q Your fund’s turnover ratio is 71%. That seems high for a fund that has “capital appreciation” in its name.

A We are a core or blend fund. A value fund on average probably has 30[%] or 40% annualized turnover.

A growth fund may have 120%, so on a blended basis, it’s going to be around 80%.

Q You were a senior audit associate with Coopers & Lybrand LLP. Has that helped you avoid any land mines?

A As a senior audit associate, I had opportunities to engage more directly with some senior management teams, both good management teams and bad management teams.

We’ve been able to avoid some names where we thought the accounting may have been questionable. One example was Williams [Cos. Inc. (WMB)]. We sold the name a day or two before the stock blew up, and it’s traded down almost to a penny stock, though it’s rebounded since.

Q You consider yourself a “bottom-up” investor. Does that make it difficult to invest in a market that’s been so top-down, with swings in interest rates, world events and markets?

A I disagree. When you’re, say, focusing on 15 names in the diversified-industrials area, the macro factors have much less effect. Macros can come into play, but we as portfolio managers have our views.

SNAPSHOT

David P. Gilmore, 32, portfolio manager of the Federated Capital Appreciation Fund at Federated Investors Inc. in Pittsburgh since 2000

Assets under management: $2.5 billion

Career: 1997-2000, analyst with Federated; 1997, equity analyst with Kiewit Investment Management Corp. in Omaha, Neb.; 1992-97, auditor in Richmond, Va., with Coopers & Lybrand LLP

Education: bachelor’s degree in accounting from Liberty University in Lynchburg, Va., 1992; master’s in business administration, University of Virginia, 1997

Federated Capital Appreciation Fund (assets, $2.5 billion): year-to-date return, 10.52%; one-year, 5.66%; three-year, -6.32%; five-year, 4.71%

Large-blend index: ytd, 12.85%; 1-yr, 8.92%; 3-yr, -0.74%; 5-yr, -0.05%

Returns as of July 31; periods over one year annualized