In a quarter when every major stock benchmark plummeted into negative territory, managers of small-cap and midcap strategies were virtually the only ones to keep their heads above water in the latest Pensions & Investments Performance Evaluation Report.
The third quarter was a debacle for value stocks. The worst major index return was that of the Russell Midcap Value index, which sank to -10.6% for the quarter. The best-performing benchmark return was the Russell 1000 with -3.7%.
Overall, growth managers returned with a vengeance, dominating the managed and commingled rankings for the quarter, one- and three-year periods ended Sept. 30.
With few exceptions, the top five managed and commingled managers for the shorter periods had a micro-, small- or midcap focus. For the three years, larger-cap won out in both universes.
The median PIPER return for separately managed equity accounts in the third quarter was -6%; all of the top 15 managed equity accounts beat the -6.2% of the Standard & Poor's 500 index by a substantial measure.
The best-performing managed account for the quarter was the small-cap growth equity portfolio managed by S E B Asset Management America Inc. that returned 16%. Following were the aggressive growth portfolio managed by Insight Capital Research & Management Inc., at 15.2%; the emerging growth equity management portfolio of Constitutional Research & Management Inc., 14.3%; the U.S. small-cap growth equity portfolio of Kern Capital Management LLC, 13.5%; and the small-cap emerging growth portfolio of Sterling Johnston Capital Management, 13.4%.
The median PIPER return for commingled funds for the third quarter also was -6%; and again the top 15 PIPER commingled funds beat the index.
But the 8.5% return of the best-performing commingled fund strategy -- Provident Investment Counsel Inc.'s small-cap growth equity fund -- was only about half that of the top separate account strategy. In second place was the Garnet Fund LP, managed by Garnet Capital Management, at 7.9%; followed by Suffolk Partners LP Fund, Suffolk Capital Management, 7.3%; and the small-cap fund of Columbus Circle Investors, 7.2%. The lone value fund among the top five commingled funds and separate accounts for the quarter and one year periods was the the GMO Fundamental Value Fund, managed by Grantham, Mayo, Van Otterloo & Co. LLC, in fifth with a 5.6% return.
The secret to Walnut Creek, Calif.-based Insight's success was an intense focus on very fast growing companies. It invests in 28 to 42 stocks, said Charles S. Gehring, vice president and senior portfolio manager. There are no capitalization limits, and turnover is relatively high -- about 160% per year.
Looking for fast growth
Insight includes only companies that are growing between four and five times the rate of the U.S. economy. Companies in the portfolio will grow an estimated average 76% in 1999, compared with 18% for companies in the S&P 500. But sustainability of growth is also important, said Mr. Gehring. Although 75% of the portfolio's assets were in technology stocks at the end of the quarter, this concern eliminates most ".com" stocks from consideration. Instead, Mr. Gehring said he likes infrastructure companies with real revenues and real earnings that are profiting from the Internet and communications booms.
Among the most recognizable stocks in the portfolio are Sun Microsystems Inc. and Cisco Systems Inc. Most of the strategy's holdings are not household names, Mr. Gehring said, such as one of the portfolio's best performers, JDS Uniphase Corp.
Another area of concentration -- comprising 11% of the portfolio's assets -- is in communications services. Mr. Gehring said his most successful stock pick in the third quarter was VoiceStream Wireless Corp.
Smaller caps win out
The median PIPER equity return for the year ended Sept. 30 was 24.1%. The S&P 500 return for the period was 27.8%, which was smashed by the top PIPER managed account returns. Each of the top 13 strategies returned more than 100% for the year, and all of the top 15 were growth-oriented micro-cap to midcap strategies.
The best-performing managed account strategy for the one-year period was the small-cap growth equity portfolio of Driehaus Capital Management Inc., with a stunning 146.6% return. Second was the micro-cap aggressive growth portfolio, managed by Sterling Johnston, at 137.9%; the small-cap equity growth portfolio of Apodaca Investment Group returned 129.6; the U.S. micro-cap equity portfolio of Kern Capital, 126.9%; and fifth was another Driehaus strategy -- the midcap growth equity portfolio -- which returned 125.2%
Being fully invested, and being in the technology and energy sectors, worked for Sterling Johnston, San Francisco, said Scott Sterling Johnston, chairman and chief investment officer.
The strategy, which has $12.5 million under management, seeks accelerating earnings momentum, strong relative price strength and a catalyst, and avoids buying new issues.
Mr. Johnston said he shuns Internet stocks in the technology sector, preferring instead the providers of peripheral goods and services, such as Media 100 Inc., Loronix Information Systems Inc., Aware Inc., Polycom Inc., Optical Coating Laboratory Inc. and ACTV Inc.
In the first quarter, Mr. Johnston said he added gaming stocks such as Boyd Gaming Corp., WMS Industries Inc. and Aztar Corp., the fund's only exposure to consumer services. He said the recovery of the Japanese economy should boost tourism to U.S. gambling establishments, providing the catalyst the strategy seeks.
Mr. Johnston also has moved up to a 20% weighting in energy stocks by the end of the third quarter. His picks included Callon Petroleum Corp., Grey Wolf Inc., Prima Energy Corp., Key Energy Group and Superior Energy Services Inc.
The median PIPER return for commingled funds for the year ended Sept. 30 was 25.7%, and all of the top 15 funds easily beat the S&P 500.
In first place among commingled funds for the one-year period was Driehaus' Small/Mid Growth Fund, offered by Massachusetts Mutual Life Insurance Co., with a 128.4% return. The gap between the top return and the next four was dramatic, with the special equity fund managed by GEM Capital Management in second place with returning 75.9%. Following were the small-cap fund of Columbus Circle Investors, 71.1%; the diversified capital growth fund of Wachovia Asset Management, 70.7%; and the emerging growth fund of Copper Mountain Trust Corp., 68.2%.
Large growth performs
The median PIPER equity return for separate accounts for the three years ended Sept. 30 was an annualized 18.2%, compared with the S&P 500's annualized 25.1%. All of the top 15 PIPER separate account strategies beat the S&P 500 in the three-year period. (All returns for periods of more than one year are compound annualized figures.)
Mt. Auburn Management's concentrated large growth portfolio held the top position, with 65% for the three-year period. In second place was the large-cap growth equity portfolio managed by Campbell, Cowperthwait & Co. at 49.9%; the small/medium cap equity portfolio of Pinnacle Associates Ltd. was next at 45.8%; the large-cap growth portfolio of Nicholas-Applegate Capital Management, 44.8%; and the large-cap growth portfolio of Trainer, Wortham & Co., 43.2%.
The median PIPER equity return for commingled funds for the three years ended Sept. 30 was 18.3%. Once again, all of the top 15 PIPER commingled funds beat the S&P 500.
The best-performing commingled fund for the period was the U.S. equities fund managed by Marvin & Palmer Associates, at 38.8%. It was followed by the Transamerica Investment Services' Transamerica equity fund, 35.1%; the Quest Group Trust, Quest Advisory Corp., 33.7%; the equity growth group fund, Chase Bank of Texas, 32.8%; and the BT Pyramid Enhanced Stock Fund, Deutsche Asset Management in the Americas, 31.9%.
Concentrated portfolios, in which the manager generally is confined to fewer than 30 stocks, did very well for the three years.
Concentration pays off
The large-cap growth equity separate account strategy of New York-based Campbell, Cowperthwait aims to invest in the best 25 stocks in the best sectors, "a recipe for fabulous long-term returns," said Mike Shields, president and CEO.
"Too many managers own too many stocks," he said, adding that owning only the leading company in each growth sector results in a diversified portfolio. Mr. Shields' $3.5 billion portfolio has an average annual turnover of only 20%. Some of the names helping the strategy's performance were MCI Worldcom Corp., Charles Schwab Corp., Microsoft Corp., EMC Corp., Sun Microsystems and Home Depot Inc. One stock Mr. Shields said is volatile, but worth it, is AOL Corp., up 600% for the three-year period. "AOL is the blue-chip stock of the Internet (sector). I'm more convinced than ever that it's the dominant player in the Internet," he said.
The Transamerica fund also uses a concentrated strategy, said its manager, Jeff S. Van Harte, vice president and senior fund manager. It holds just 28 names, what Mr. Van Harte called "some of the greatest wealth-producing machines in the world."
A company combining low cost and high functionality is Charles Schwab Corp., the fund's top holding. And he bought Dell Computer Corp. just after it entered its turnaround phase and Microsoft just as Windows 3.1 was introduced. Similar holdings are Intel Corp., Applied Materials Inc. and Cisco Systems.
Mr. Van Harte also likes the supermarket business. He bought 20% of Smith Food & Drug when it was a leverage recapture deal; it then merged with Fred Meyer, which merged with Kroger Co, now the fund's eighth largest holding.
Mr. Van Harte admitted that while the Transamerica equity fund does have a growth bias, he is opportunistic, buying value stocks that fit the "best of breed" criteria and holding them for a long time.
"If the fundamentals and the growth prospects are good, even if you pay a little too much at the outset, you'll get it back," he said.