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SPECIAL REPORT

TOP-PERFORMING MANAGERS

November 29 , 2021

Small-cap value strategies make big comeback

By JAMES COMTOIS

Small-cap strategies continue to top the list of the best-performing domestic equity strategies, making up nine of the top 10 strategies for the year ended Sept. 30, according to the latest data from Morningstar Inc.'s separate account/collective investment trust database.

 

All of the top 10 strategies recorded triple-digit gross returns. Of the top 10, six were blend strategies, two were value, one was growth and one was financial, according to Morningstar categorizations.

 

This marks the third consecutive quarter that small-cap strategies dominated the top 10 rankings. For the year ended June 30 all 10 top domestic equity strategies were within Morningstar's small-cap category.

 

The overall median return for domestic equities within Morningstar's separate account universe was 32.77% for the year ended Sept. 30, compared to the Russell 3000 index return of 31.9%.

 

Tony Thomas, senior manager research analyst for equity strategies at Morningstar in Chicago, said in a phone interview that at "this point last year, it (small-cap value) was probably the ugliest segment of the market. Now, it's the hottest sector."

 

In fact, from 2017 through 2020, small-cap value "was the weakest segment," Mr. Thomas said. "They had a long period of significant underperformance."

 

For the year ended Sept. 30, the Russell 2000 index returned 47.6%, while the Russell 2000 Value index returned 63.9% during that same period.

 

Mr. Thomas explained that a number of these small-cap value strategies "have significant exposure to energy, and with improving oil prices and improving oil demand, that's benefited these managers." He added that "meme stocks" like GameStop "have (also) helped some of these strategies."

 

Small-cap value stocks include a "heavily cyclical segment of the market," with "a lot of financials and small retailers in there; areas that were badly beaten up last year," the Morningstar analyst added.

 

"If there was a segment in the market that was cheaper last year, it was in small value," Mr. Thomas said. "So, investors are seeing an opportunity."

 

For the year ended Sept. 30, the median return for overall blend strategies was 48.28% in Morningstar's universe, while value strategies returned a median 41.42%. The Russell 3000 Value index returned 36.6%. Growth strategies, as measured by Morningstar, returned a median 31.41%.

 

For the second consecutive quarter, DOMO Capital Management LLC topped the list of the best-performing domestic equity managers. For the year ended Sept. 30, the Germantown, Wis.-based manager's Concentrated All Cap Value strategy returned a gross 136.24%.

 

David Ribbens, a partner at DOMO Capital, said that with this strategy, the firm seeks to retain a concentrated portfolio.

 

"We're opportunistic buyers," he said. "There's been a bit of a rotation to value. We've seen over this past year more investor interest in beaten-up names that don't deserve their low valuations."

 

United Natural Foods Inc. , a Providence, R.I.-based natural and organic food company, was a big contributor to the strategy's performance, he said. DOMO Capital sold its position within the food supplier and redeployed the proceeds.

 

"COVID turned out to be a tailwind for groceries, since people stopped going to restaurants," Mr. Ribbens said.

Old West Investment Management LLC's Small Cap and All Cap Opportunity strategies ranked second and fourth on the list, respectively, returning a gross 115.35% and 107.7%, respectively.

 

Joseph Boskovich Jr., co-founder and partner of the Los Angeles-based manager, attributed the strategies' strong performances to metals and the uranium mining space, both of which saw a huge demand "because of the clean energy revolution."

 

Mr. Boskovich said: "We built a position in uranium mining three-and-a-half, four years ago, which has performed phenomenally,"

 

Uranium mining and nuclear fuel stocks that did particularly well in Old West's strategies included  Cameco Corp. , Saskatoon, Saskatchewan;  Energy Fuels Inc. , Lakewood, Colo.;  NexGen Energy Ltd. , Vancouver; and  Centrus Energy Corp. , Bethesda, Md.

 

The firm also identified companies led by management teams "that have great records of capital allocation and buy their own stock, so the management (teams) have more to gain or lose than from compensation," Mr. Boskovich added.

 

Those holdings that performed well during this period included  WildBrain Ltd. , a Halifax-based media, production and brand licensing company;  Fulgent Genetics Inc. , a Temple City, Calif.-based genetics testing firm;  Zedge Inc. , a New York-based content distribution firm; and  St. Joe Co. , a Watersound, Fla.-based land development company.

Vulcan Value Partners LLC, Birmingham, Ala., had the third-ranked strategy for the year ended Sept. 30. Its Small Cap Equity strategy had a gross return of 109.22% for the period.

 

C.T. Fitzpatrick, founder, CEO and chief investment officer of Vulcan Value Partners, said the firm seeks "companies that have inherently stable values over the long term, with strong balance sheets."

 

"It's all security selection," Mr. Fitzpatrick said. "We didn't overweight to this industry or that. We're bottom-up people. The building blocks are the businesses themselves."

 

He said the top two contributors to the strategy's success were  Upstart Holdings Inc.,  a San Mateo, Calif.-based consumer lending company, which was "really discounted compared to its potential"; and  Park Hotels & Resorts Inc. , a Tysons, Va.-based REIT, which Vulcan bought at "an enormous discount."

 

And while these firms may not seem to be alike in obvious ways, the Vulcan chief executive explained that they do share some essential attributes.

 

"They have stable values, a lot of free cash flow, sustainable competitive advantages and are managed by really good people," Mr. Fitzpatrick said.

 

The manager also owns several real estate service companies, that provide sales, leasing and advisory services and property management, that have done well, since they don't own assets and can pivot, such as  Cushman & Wakefield PLC Jones Lang LaSalle Inc ., and  Colliers International Group PLC.


"They took a cyclical hit during the pandemic, but we thought people would continue to need apartments and warehouses, and that over the long term these businesses could skim the cream off the top of the real estate sector," he said.

 

The firm also sold positions in the following three companies: office furniture manufacturer  Knoll Inc. , laser manufacturer  Coherent Inc. , and British aerospace company  Meggitt PLC .

 

"We bought Noel, Coherent and Meggitt at 50 cents on the dollar or better, then sold (at) 100 cents on the dollar or better," Mr. Fitzpatrick.  Kennedy Capital Management  Inc. had strategies that came in fifth and sixth on the list for the one-year period. The St. Louis-based manager's Bank Sector strategy returned a gross 106.13% for the year ended Sept. 30, while its Micro Cap Emerging Growth strategy returned a gross 105.86%.

 

Although Donald Cobin, president, chairman and CEO of Kennedy Capital Management, declined to point out any specific holdings within the strategies that performed well, he explained that the firm's bank sector strategy tends "to follow underfollowed, unknown banks that are more on the micro and small end of the spectrum."

 

The strategy also looks for "banks moving into specialized services, so the payment space, credit cards and banking as a service," Mr. Cobin said in an interview.

 

For the Micro Cap strategy, the sectors that outperformed during the 12-month period included health care, technology, industrials, materials, financial services and real estate, he said.

 

"Both of these strategies tend to follow underfollowed opportunities, so they're not beholden to cyclicity or strategic shifts in the market," Mr. Cobin said.

 

In the same interview, Anil Thomas, managing director and head of consultant relations and institutional sales at Kennedy Capital Management, added: "These are not trading-oriented products; we don't go in and out of investments quarter to quarter. So, if there's short-term volatility, we can maintain our conviction."

 

Mr. Thomas from Kennedy Capital later said in an email that the firm was looking to change the Micro Cap Emerging Growth strategy's name to Micro Cap Opportunities by year-end "to avoid benchmark confusion."

 

Growth still on top over five years

 

For the five years ended Sept. 30, eight of the top 10 strategies were growth-oriented. Five of those strategies fell within Morningstar's small-cap category, while two were categorized as midcap and one as large cap. Two of the top 10 strategies fell within Morningstar's technology category.

 

Topping the list was one of the two technology strategies: New York-based ARK Investment Management LLC's Next Generation Internet strategy, which had an annualized gross return of 45.76% for the five years ended Sept. 30.

 

Next Century Growth Investors LLC's Micro Cap Growth strategy ranked second for the five years ended Sept. 30 with an annualized gross return of 42.03%, and  Zevenbergen Capital Investments  LLC's Genea growth strategy ranked third with an annualized gross return of 40.63%.

 

The median five-year annualized return for domestic growth strategies in Morningstar's domestic equity separate account universe was 19.9%, and the median among all domestic equity strategies was 14.54%. The Russell 3000 Growth index returned an annualized 22.3% for the five years ended Sept. 30, and the Russell 3000 index returned an annualized 16.8%.

 

Within the collective investment trust universe for the year ended Sept. 30, nine of the top 10 domestic equity CITs were small-cap strategies and one was a midcap strategy. Of the top 10, nine were value strategies and one was a blend strategy.

 

Leading all trusts was American Century Investment Services Inc.'s U.S. Small-Cap Value Equity CIT with a net return of 70.44% for the year ended Sept. 30.

 

The median return of domestic equity collective investment trusts in Morningstar's universe for the year ended Sept. 30 was 33.57%.

 

For the five years ended Sept. 30,  T. Rowe Price Group  Inc.'s New Horizons Class A CIT led all trusts with an annualized net return of 27.36%, followed by State Street Global Advisors' Nasdaq 100 Index Class A CIT, with an annualized net 25.95%.

 

All data for  Pensions & Investments ' top-performing managers report are provided from Morningstar's global separate account/collective investment trust database. The data for the rankings on which this story is based were pulled Nov. 4.

Old West Investment Management Small Cap product ranked #2 for one year and Old West Investment Management All Cap Opportunity product ranked #4 for one year in the Overall U.S. Equity separate accounts universe for 3Q, 2021. Source: Morningstar.

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