A home builder. A defense contractor. A retailer specializing in cowboy boots and other Western wear. A subprime automotive lender. An industrial-metals processor. An asset-management company.
Some of these publicly traded entities are small businesses; others are larger. They respond to different market cues and participate in different economic cycles. Some could be defined as “value” companies; others are favored by investors who seek out growth.
However random this group of stocks seems to be, the companies share one characteristic: Each played a role in helping a handful of U.S. mutual-fund managers post outsize returns in 2021.
Fund-tracker Morningstar Inc. defines nine out the 10 funds that topped The Wall Street Journal’s quarterly ranking of outperformers as small-cap value managers. But the Winners’ Circle results for the rolling 12 months ended Dec. 31 demonstrate the extent to which definitions of “value” can differ widely from one portfolio manager to another.
“There are multiple ways of measuring value,” says the No. 1 finisher among the managers, Elena Khoziaeva, head of U.S. equity at Bridgeway Capital Management. Anyone relying on price-to-book ratios to flag potentially attractive investments in 2021 would have been disappointed, she says. Another common measure of value, however, the venerable price/earnings ratio, fared well.
Using that metric, along with measurements of “quality” (or the financial health of a business), helped Bridgeway Small-Cap Value (BRSVX) capture top honors in this quarter’s ranking after two quarters as a runner-up. (It was one of three Bridgeway small-cap value funds to make the ranking’s top 10.)The fund’s 67.7% return for the year handily beat its nearest rival: Beck, Mack & Oliver Partners Fund (BMPEX), which posted a gain of 53.7%.
The winning fund returns are in contrast to the average performance of the 1,329 U.S. stock funds that qualified for this Winners’ Circle ranking—those that have at least $50 million in assets and a record of at least three years, and that are actively managed. For 2021, this group posted an average gain of only 11.8%, compared with returns of more than 50% for the top four funds in the survey. The average performance of the 1,329 funds also trailed key indexes, such as the Russell 2000 (a gauge of smaller stocks, up 14.8%) and the Russell 1000 Value (which advanced 25.2%).
(A caution about these quarterly Winners’ Circle surveys: They might identify funds that do particularly well over the most recent 12 months, but that doesn’t mean investors should view this ranking as a list of recommended funds. Some funds may have above-average fees or below-average liquidity; some might not be easily accessible to all investors or appropriate for portfolios for other reasons.)
Rich Fitzgerald, co-manager of the Beck, Mack & Oliver Partners fund, and one of eight investment-team members responsible for developing the firm’s “buy list,” says that not being tied to a rigid definition of value helped the team boost returns.
“We have our own spin on value,” he says. “We’re really looking for dislocations or opportunities to acquire excellent businesses that we can imagine owning forever.”
Many paths to glory
In the past, when funds that invest in larger companies have dominated the rankings, names like Apple or Amazon.com frequently have appeared on all the lists of top holdings and companies that were major contributors to returns. Today, heading into the third year of a market characterized by uncertainty surrounding the coronavirus pandemic, fund managers find that there can be many different paths to top-tier returns.
For Ms. Khoziaeva, who relies on data screens to identify stocks she believes have the characteristics to outperform, companies as diverse as Beazer Homes USA and Ryerson Holding Corp. (an industrial-metals processor) popped up as offering value last year, and contributed significantly to her fund’s returns.
At Beck, Mack & Oliver, a New York-based firm whose major business is overseeing separately managed accounts for its high-net-worth clients, Mr. Fitzgerald says his fund looks to invest in businesses whose fundamentals are out of line with their market values. One example is the subprime auto lender Credit Acceptance Corp. While the phrase “subprime” may scare off many investors in the aftermath of the 2008 financial crisis, Mr. Fitzgerald says his colleagues looked past volatility and occasional controversies to focus on the company’s core business.
“Their model gives dealers an incentive to put borrowers in cars they can afford, with loans they can afford,” he says. Moreover, he says that the company becomes more conservative whenever the demand for cars and loans booms. “They don’t fall into the trap of being aggressive in writing new business.” The stock nearly doubled over the course of 2021.
Other positions that have done well for both Beck Mack’s more affluent clients and investors that were drawn to its mutual fund in the past year include household names such as paint manufacturer Sherwin Williams Co. and asset-management giant BlackRock Inc. But the team also finds small companies, such as Advanced Drainage Systems Inc.
“It’s a well-run industrial company that makes plastic piping,” Mr. Fitzgerald says. “It’s not well followed by Wall Street, but it does a great job at cutting expenses and increasing its business.” The stock jumped about 46% last year.
Score at the Quarter
Stock funds hammered out their sixth positive quarter of the past seven. Average total return for U.S. diversified funds.
The third-ranked fund in our 2021 survey is Oberweis Micro-Cap Fund (OBMCX), which posted a gain of 53.4% for the 12-month period, while outpacing both of this quarter’s top performers when looking at three-year and five-year annualized returns.
The fund’s manager, Ken Farsalas, doesn’t define himself as a value manager but says he often invests in undervalued businesses. His fund looks for investment opportunities in positive earnings surprises.
“We want to be buyers in companies that exceed expectations, when the reason for that surprise is that they’ve launched a new product, or a new management team is taking the firm in an interesting direction,” Mr. Farsalas says. Despite research that shows these kinds of earnings surprises tend to indicate a lasting improvement in the company’s financial position, he says, “most investors still tend to underestimate the impact of those changes” on stock prices.
At the beginning of 2021, he says, the Oberweis portfolio was “dirt cheap” on a price/earnings ratio basis, despite including businesses that were picking up market share, like Boot Barn Holdings Inc., a Lehigh, Pa., maker and retailer of Western footwear and specialty work footwear and clothing. Boot Barn sells its own brand and others through its 275 bricks-and-mortar stores, mostly in the West and South, and online. “They compete primarily against mom-and-pop retailers, which [at the height of the pandemic] were struggling to stay afloat,” says Mr. Farsalas. “At the same time, they’ve had a lot of success launching their own brands, which have higher margins.” Boot Barn shares soared nearly 149% last year.
Cyclical companies tied to the health of the overall economy also have offered earnings surprises—and value—for Mr. Farsalas and his investors. These include Veritiv Corp. , a business-to-business packaging company, and Axcelis Technologies Inc., a semiconductor-equipment manufacturer.
James Davolos, manager of the fourth-ranked fund for 2021, Kinetics Small Cap Opportunities Fund (KSCOX), up 50.3%, also found value in cyclical businesses. Although he gravitated primarily to companies with exposure to hard assets, such as real-estate developers, contributors to the fund’s performance included a new kind of defense contractor, CACI International Inc.
“Instead of making missile systems or other weaponry, they specialize in stuff like data encryption and satellite communications,” Mr. Davolos says. “There are decades of secular growth ahead for this company, and the market is just starting to understand that its growth isn’t dependent on who controls the House of Representatives or the Senate.”
Ms. McGee is a writer in New England. She can be reached at firstname.lastname@example.org.
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