NEW YORK (CNN/Money) – The investing landscape couldn't be more bleak. The average U.S. stock fund is down 9.6 percent this year. Tech funds, telecom funds, large-growth. You name it, they're all hemorrhaging red ink.
But small-cap value funds have been the rare exception. The funds are up nearly 3.6 percent this year as of June 13, one of only a handful of stock fund categories making money. And small-cap value stocks were winners in the past two years – up 8.9 percent in 2001 and 17.4 percent last year. Click here for more on the small cap rally, and click here for more on the trend of small-cap funds closing, from MONEY.
(Of course, not all small caps came to the party -- small growth stocks, which included many defunct Internet companies, have struggled along with everything else.)
One of the top small-cap value performers is Skyline Special Equities Fund. The fund, with $578 million in assets, is up 10.1 percent year to date as of June 13, according to Morningstar. It has earned an annualized 14.9 percent in the past 10 years. Maloney recently spoke with CNN/Money about the outlook for the sector.
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| Mike Maloney |
Small value has been such a leader for so long. Can it continue or is the rally over?
We think a lot of the imbalances that were created in the bubble have been corrected with the outperformance of small-cap value in the last couple of years. A couple of years ago, there were unprecedented opportunities. Now, there are still opportunities out there; you just have to work harder to find them.
Earlier this year, we had 9 percent in cash for a number of reasons. We had strong flows into the mutual fund. Also, we're very disciplined. So when a stock hits our price target, we sell, and sometimes there's a lag until we replace it with a new idea. But now, we're down to 2 percent. We've found a lot of opportunities to put the cash to work. The Russell 2000 Value Index corrected 10 percent in the past month. The possibility of war between India and Pakistan, and the potential for more terrorist attacks, is making people nervous. And that's overshadowing what for the most part has been pretty good news on the economic front. The 2 percent level is actually pretty low – we tend to fluctuate between 2 percent and 9 percent.
Where have you been finding the best opportunities lately?
We take a bottoms-up approach. Our best ideas will benefit from an improving economy but they also have something going on internally -- either a restructuring story or a new-products story that will help them grow their earnings at an accelerated rate.
One of the names we like a lot is Toro. It's a recent addition to the portfolio. Their biggest segment is the landscape contracting market. This is a growing area and it's over 50 percent of the business. We think that business will continue to grow. And just recently, they started selling lawn mowers through Home Depot. This agreement will allow them to grow more rapidly. So there are two drivers to revenue growth. In addition, the company is doing a lot of things to improve their profitability .They're consolidating facilities, and moving some production to Mexico to take advantage of lower labor costs. It's a solid growth story.
Another name we like is Provident Financial, a Cincinnati-based bank. It's a cheap stock, trading around $25, or 11 times earnings, while the typical bank stock trades at 13 or 14 times earnings. A few years ago, the company got into trouble straying out of its core business -- it began aircraft leasing, not a business a regional bank should get into. But a new CEO came in a few years ago (Robert Hoverson) and now they're focusing more on retail banking, and the consumer. They're looking at 17 percent earnings growth in the next year.
Some managers say smaller companies are less likely to have accounting improprieties than large ones because they have simpler business models. Do you have an easier job avoiding accounting blowups than large-cap managers?
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I think that's a good point. For the most part, we try to keep it very simple. We're very numbers-oriented, focusing on the financials and the footnotes and making sure we understand a company's business model and how it drives its earnings.
But accounting fraud goes on in small-cap land as well. Enron and Tyco were big companies and you had so many Wall Street firms analyzing them. With small companies, you are one of the few people doing work on them. You really have to be careful.
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