Tom Bastian started managing money in 1997, right before the Asian financial crisis hit. The ensuing plunge in those markets helped form his investing philosophy. Today Bastian, who runs the $11.7 billion (assets) Invesco Equity and Income Fund, obsesses about what might go wrong. “I’m fairly conservative anyway,” he says, “but those experiences emblazoned on me the need to manage and understand the downside risk.” That means Bastian focuses on value — in any market. About two-thirds of his fund’s assets are in stocks, with fixed-income and convertible bonds — which offer the income of bonds and the potential upside of equities — making up the rest. The strategy has paid off: Over the past three years, the fund has returned an average annualized 13.6%, vs. 10.7% for its category, according to Morningstar. Bastian, 49, described how finding beaten-down stocks protects against calamity. Edited excerpts:
In a difficult and uncertain environment, what’s your strategy?
Everything we do is driven by trying to get risk/reward in our favor. We want to find companies that are unloved, undervalued, and under-earning, and then find a catalyst that allows us to participate on the upside.
Financials are your top sector. What do you see there?
In the 2004-2005 period, when they were overearning and everybody loved them, we went underweight. That didn’t do much for us then. In 2008 it helped us dramatically. Since the end of 2008, we have gradually and opportunistically added to the financials. We think broadly that they are still under-earning relative to historic levels, and the rules of engagement are becoming clearer and clearer.
Where do you see opportunity?
We became interested in Morgan Stanley about a year ago. At its peak it traded at over six times book value. When we bought last year, it was at 0.5 times book. [Today that figure is 0.8.] They have spent a lot of time cleaning up the balance sheet. I feel much better about that book value than in the past. Another is Bank of America. It’s still selling at a meaningful discount to book value, and it’s under-earning. They have a credible plan to take out expenses, and they seem to be executing on it. One thing that concerns us is the tail risk on the litigation exposure. We worked with different analysts and tried to juxtapose reasonable and worst-case analyses of the litigation. We looked at the impact it could have on book value, and got comfortable that they could absorb it.
You’ve got a big stake in Avon, which has had its own troubles. What do you see in it?
It was a name that screamed “wealth” for us for a long time. They had a change in their financial management a few years ago, and the individual on my team who covers the space said they’d set out a plan to reach mid-teens operating margins. He said to me, They’ve had several cracks at getting back to normal and not done particularly well. If they don’t do it, we’ll probably get a management change. They mis-executed, brought expectations down, and Andrea Jung left. They hired Sherilyn McCoy from J&J in April 2012. We talked with her shortly after she was named CEO, and she seemed very pragmatic and not in the business of overpromising. We are seeing operating margins slowly but surely improve, and we have seen an inflection in the sales already.
Your fund also owns a number of tech stocks. What is one you like?
Symantec. Over the last five years, they’ve done 19, plus or minus, M&A deals. The management team didn’t do a great job integrating them, and the CEO was replaced. Steve Bennett came in. He had been at GE, and then had a great run at Intuit. So when he came to Symantec we got real interested in the stock. He said, We’re going to do less M&A and focus more on operations, and long-term we’re going to look at returning capital to shareholders with buybacks and ultimately dividends. These are things we look for, and he’s begun to make progress.
The fund has a big chunk of convertible bonds. Why?
We like convertibles because it’s one of those asset classes that not a lot of people pay attention to. In our category, what has really differentiated us is convertible securities. What we look for is similar to what we’re looking for on the equity side. We’ve bought some of the mortgage insurers, Radian and MGIC. Coming out of this crisis, as you can imagine, they were suffering a tremendous amount of credit losses. They were unloved, and they needed capital. They issued equity and convertibles, and that gave them the opportunity to write mortgage insurance and begin to take market share.
What do you think about the increase in convertibles this year?
There are more convertibles issues so far this year than for all of last year. But it’s low on a historical level. The fixed-income markets over the past couple of years have been willing to finance anything at historic rates. As rates come back up, we’ll probably see convertible issuance pick back up. We like them to be between 15% and 20% of the portfolio. We had a lot of calls on the convertibles, and we’re working real hard to get that level back up.
This story is from the September 16, 2013 issue of Fortune.
