Best performance over three years comes from funds with a long-term low exposure to high beta stocks such as technology
US smaller companies funds that performed well over the past three years were generally bottom up stock pickers. Value stocks have been the winners during this period and most of the better-performing funds had a long-term strategy of low exposure to technology and other high beta stocks. The sectors that performed well included energy and financials. Most growth-orientated funds lost out heavily.
The Carlson Equity American Small Cap fund was the best performing fund in the US smaller companies sector over three years.
According to James Dwinell, managing director and portfolio specialist at DL Babson, sub-advisor of Carlson, the fund performed well because of its long-term strategy and stock picking process.
Companies are chosen for the long run and must demonstrate certain characteristics such as strong management, products that are superior to others, conservative business plans, and steady growth in the long term.
Dwinell says: 'We stay away from cyclical industries because they do not have long-term potential, instead aiming for long-term consistent performance, which is more resilient to short-term economic weaknesses. Companies have to have longer-term pricing cycles as well as the right price to be considered for the portfolio.'
On the other hand, a company would only be sold if the business had fundamentals that would deteriorate: for example, if a business had a backlog in shipping orders that increased its costs. Another reason may be because a stock has reached its target or there are better opportunities elsewhere. Also, the team starts thinking about trimming at a 4% holding. The absolute maximum is 5%.
May 2000 to May 2001 was a strong period for the portfolio and overall it was ranked second percentile. Dwinell says many of the stocks held in this year are still in the portfolio today.
In May 2001 the strategy for the portfolio remained the same. The portfolio dropped back slightly relative to its peers to the 7th percentile for the following 12 months. Dwimmel says this is simply because it was a high growth denominated market and the fund does not invest in these types of companies.
The weakest period for the portfolio was between May 2002 to May 2003. This was driven in the fourth quarter of 2002 as there was a strong rebound in technology and biotechnology sector and, as has been mentioned, the portfolio does not hold high beta growth companies.
The 'Asset' sub fund of the Luxembourg-based Callander fund was ranked number three over the recent three-year period. Breaking the performance up into year segments, it has been pretty consistent, aside from a slight drop in performance over the past 12 months when it dropped back to the 23rd percentile ' though still top quartile.
According to Catherine de Christen, associate director at Cerepfi, the good performance can be attributed to only a small number of technology stocks in the fund and it having a value approach.
In 2000 the fund performed very well and was ranked in the 4th percentile. This was achieved through overweightings in the energy sector following good performance in the oil service area, and in the financials that benefited from a decline in interest rates during the second half of the year.
In the beginning of 2001 the good performance was also attributed to the near absence of technology/telecom investments.
From May 2001 to May 2002 the fund was ranked in the 8th percentile. In this year the fund's value strategy paid off and good performance was attributed also to selective addition of technology companies at depressed levels later in the year.
While valuations in the technology/telecom sector remain excessive the survival of many companies was in doubt. The carnage has also driven down many individual stocks to boundaries of value investments.
In 2002 the fund also held a tactical position in cash because of period of extreme geopolitical uncertainty. The fund also performed well because of its bottom up stock picking approach.
Stock selection used for the Callander Fund Asset portfolio is based on a three-pronged approach: companies are either asset based, value-orientated or event driven.
Asset based companies must have visible delineated assets that exceed by a wide margin the price of the share.
Value orientated companies must trade at a sharp discount to market P/E despite above-average growth; have a financially conservative balance sheet; generate enough cash flow from operation to finance normal growth; frequently repurchase their shares; and possess unrecognised assets and/or franchises.
Event driven companies are those that possess most of the attributes of value but also have the potential of some action, driven either by management or by external forces.
JP Morgan Fleming has had mixed fortunes in this sector, with one fund in the top 10 and two funds in the bottom 10 over three years. The JPMF America Micro Cap A-USD was ranked number nine in absolute terms, the JPMF US Select Small Cap A was 52nd out of 53 and the JPMF America Small Cap A-USD was 51st.
Christopher Jones, head of small cap group at JP Morgan Fleming, says: 'The JPMF America Micro Cap A-USD is sector agnostic ' our stock picking approach is a bottom up process. Companies are held for the long term on a three-five year time horizon.'
Companies are chosen according to their competitive position. The quality of the company's business model is examined along with strength of organisation of management. The fundamentals Jones looks at are companies that tend to be under-capitalised relative to larger competitors, but not at a disadvantage to them.
Jones does not look for cyclical businesses and the portfolio also has a relatively low exposure to technology. This is because it is hard to find companies that fit a competitive profile in a high beta technology market.
The performance of the fund has varied substantially from month to month.
Between May 2000 to May 2001 the JPMF America Micro Cap fund was ranked in the 17th percentile. Jones says in 2000 the good performance can be attributed to its weighting in healthcare.
From May 2001 to May 2002 the fund improved performance for the year and it was ranked in the 5th percentile. Jones says the dominant factor was stock selection and it had relatively low exposure to technology.
In the last 12 months the stock selection dropped significantly and it was ranked in the 57th percentile. According to Jones this was because of holdings in healthcare stocks. This area did not perform as well as expected and many small companies in this industry were sold down.
Jones was only willing to comment about why the JPMF America Small Cap fund was in the bottom 10 and was ranked in the 51st percentile. On the JPMF US Select Small Cap he did say there has been personnel changes as a result of the dreadful performance.
In regard to the JPMF America Small Cap fund, Jones says the main factor that contributed to the bad performance over each one of the past three years is that it is growth fund and it is benchmarked against a growth index. Value has outperformed growth over the past three years and so the fund under performed.
The investment strategy used for the fund was similar to the JPMF America Micro Cap portfolio, but more growth orientated. Companies must have a leadership position, above average earnings and cash flow growth.
But, Jones says: 'The fund was blinded by macro factors in the marketplace. We thought the economy was starting to recover but then it flipped back over and the severity of this was missed.
'Corporate and capital expenditure was hurt. The fund suffered because of weightings in the technology and software sectors.'
The investment strategy used for the fund has since been changed and Jones now uses a different sell discipline.
Previously the fund had too much exposure to certain themes such as technology and software and now there are restrictions on exposure to certain industries.
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