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A small cap fund for the big picture

When it comes to small companies, slow and steady has worked for this manager.

By Mina Kimes, reporter
February 12, 2009: 10:19 AM ET

NEW YORK (Fortune) -- While few small cap stocks are household names, those in Intrepid Small Cap Fund's portfolio are bit more esoteric than most.

The fund's second-biggest holding is Oil-Dri Corporation of America - a leading producer of cat litter. "I'm not even sure where I found that one," admits manager Eric Cinnamond.

Intrepid's tiny (it's only invested in 30-50 companies at a time), highly diversified collection of value stocks may be unusual, but it's also held up extremely well in a tough environment for small caps. Small value funds averaged -14% returns over the last three years, according to Morningstar; Cinnamond's fund achieved a category-leading 4% gain in that time.

Over the last year, small cap value funds lost 36% while Intrepid Small Cap dropped just 7%. It's the only fund of its kind that's made gains over the last three months.

Cinnamond, who works in Jacksonville Beach, Fla., started off as a small cap manager at Evergreen Investments. He helped open Intrepid's small cap fund four years ago with the intention of finding stable market leaders, often in niche industries, with normalized earnings.

"When most people think of small caps, they think of go-go high risk volatility - exciting tech stocks," he says. "But we're not looking for the next Microsoft (MSFT, Fortune 500). We're just hoping to find a good business at a good price and not screw up."

In the past, Cinnamond's slow and steady approach has occasionally looked overly cautious. When he opted not to buy tech stocks in the late 90's, he was one of the few managers who didn't make money at the time. That strategy paid off, when the dot-com bubble burst.

Many small cap funds were burned last year because they bought the pint-sized versions of AIG (AIG, Fortune 500) and Countrywide. Take Horizon Financial (HRZB). It's a Bellingham, Wash.-based bank holding company with just $1.4 billion in assets, but sizable loan and construction-related losses knocked its stock down 71% in 2008.

"A cat litter company, a beer company - I can value those with confidence," says Cinnamond. "We'd look at the small banks and homebuilders' balance sheets, and had no idea what their assets were worth."

Small cap managers like Cinnamond are, first and foremost, researchers. Investment banks rarely ask their sell side analysts to cover companies such as Zebra Technologies (ZBRA), a bar code maker, or Scholastic (SCHL), the children's book publisher (both Intrepid investments). So rather than wait for analysis to land on his desk, Cinnamond pores through the companies' reports himself and calls up management to learn about their businesses.

"I know quite a bit about cat litter," he says. "There's scoopable, there's coarse." Cinnamond says Oil-Dri (ODC) exemplifies the type of company he's looking for: The business has a consistent cash flow, sells private label products to larger companies like Wal-Mart (WMT, Fortune 500), and it has a stable end market. "You know - cats," he says.

Intrepid Small Cap gets some of its edge from its diminutive size - the fund only holds $47 million (that's up from $6 million in 2005). Most of the companies in its book are too small to make a different in larger portfolios, where managers must own a much wider variety of companies to meet the demands of investors.

"If you're Fidelity and you're running a billion dollar stock fund, you can't buy Oil-Dri and benefit," says Cinnamond. "Even if you buy the whole company, it's just a small percentage for you - it won't make a difference." But at Intrepid, the success of a small company can produce major returns for investors.

Many small cap funds do hold less than $200 million for that reason. But Cinnamond says they still end up with results that are basically indexed. Most of Intrepid's stocks come from outside the Russell 2000 (RUT) small cap index, which is why the fund produces results that diverge from the benchmark. In order to keep it that way, Cinnamond says he will have to close the fund to new buyers if it gets too big.

Excessive fund inflows aren't a problem for most managers these days, but small cap funds are beginning to attract more attention from investors. One reason: Financial pundits are buzzing about the likelihood that small stocks, which historically outperform larger ones right after a recession, will lead the market rebound. During the last recession, the Dow Jones industrial average (INDU) fell 1.8% between 2001 and 2003, while the Russell 2000 jumped 20%.

Cinnamond believes that an early recovery among small stocks is possible (largely because most small companies are domestic, he says), but he's unconcerned as to how that might affect his fund.

"We really just focus on individual companies, and try to ignore market fluctuations," he says. "We're the tortoise - and the tortoise always wins in the end, right?" To top of page


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