TROY, Mich. - At first glance, January 2000 seemed like an odd time for two portfolio managers at a large firm to strike out on their own and open a small-cap value shop.
But to Jeff Petherick and Mary Champagne, the timing couldn't have been better.
A year ago, when they left their jobs as vice presidents and portfolio co-managers for the Loomis Sayles Small Cap Value Fund at Loomis Sayles & Co., Boston, Mr. Petherick and Ms. Champagne already had seen up close how the market had battered value stocks.
In 1998, median small-cap value stock returns of -4% trailed the median returns of large-cap and midcap value stocks by 17 points and 8 points, respectively, according to Pensions & Investments' Performance Evaluation Report. Small-cap value also lagged far behind small-cap growth stocks' 6.5% median return in 1998.
The following year, small-cap value caught up to other value stocks, but fell far short of the double-digit returns of growth stocks, the Standard & Poor's 500 stock index and the Russell 2000 index, according to PIPER.
"That period was horrible for small-cap value," Mr. Petherick recalled. "We held our value pretty well (at Loomis Sayles), but there were a significant number of stocks that were hit hard. When we walked out the door, it looked like it was really a bad time to start a small-cap value fund. We were hopeful small-cap stocks would make a comeback, and value in particular."
Knowing that stock cycles tend to be cyclical, Ms. Champagne said she and her partner believed small-cap value had seen the worst of the downturn.
"The history for value was the only thing that made me think it was OK," said Ms. Champagne, who by then had already started two successful small-cap value funds essentially from scratch at other companies. "It was as low as it could go. We had been so far out on the growth spectrum that it seemed sure that if it wasn't in the first year, we would eventually see the market come back to us."
Today, NorthPointe Capital Inc. has nearly $400 million in assets under management for 12 clients comprising four foundations, three corporations, three union funds and two public pension funds. NorthPointe's small-cap value fund covers 100 to 125 companies with market capitalizations of between $100 million and about $2.5 billion. That fund has about $200 million in assets. The firm also has an "extended small-cap value" fund covering 90 to 100 companies with market capitalizations of $750 million to $4 billion and a large-cap quantitative fund with portfolios of 80 to 120 stocks of companies with market capitalizations of between $5 billion and $270 billion. Those two funds combined have about $180 million in assets.
NorthPointe recently signed two new clients whose investments are expected to increase the manager's assets under management by 50% or more, said Mr. Petherick. He and Ms. Champagne preferred not to name the new clients, or more than a few of their current clients.
Villanova Capital, Conshohocken, Pa., a subsidiary of Columbus, Ohio-based Nationwide Financial Services Inc., bought a majority equity stake in NorthPointe the same month it opened. That provided capital and removed from NorthPointe the burden of back-office operations and management functions, leaving the NorthPointe personnel free to focus on their strengths: picking good value stocks.
Value stocks as a whole appear to be turning around. Small-cap value stocks reported a 12.3% median return for 2000 through Sept. 30, according to PIPER. That compares with a -1.4% median return for the S&P 500. It lags by only a few points the median returns for midcap and small-cap stocks, which are down significantly from the mid-50% returns of a year earlier.
NorthPointe's return for the same period was close to 30%, which put it in PIPER's top decile for year-to-date small-cap value performance. The fund's 7.1% third-quarter return was in the fourth decile, still above the median.
"We've really held our value well, even in this latest selloff," Mr. Petherick said.
At least one NorthPointe client would agree. John Casey, treasurer at the $260 million Altman Foundation, New York, invested for two years in the Loomis Sayles small-cap value fund run by Mr. Petherick and Ms. Champagne. When they left, he kept his business, about $25 million, with them.
Mr. Casey, who said he insists on meeting the people who manage the foundation's money, is blunt about why he chose NorthPointe: He likes Mr. Petherick and what he does with the foundation's money.
"If I had based my decision on what they had done in the past, we would have left," Mr. Casey said, citing sub-par returns at Loomis Sayles. After the move, though, "They made some great calls. They stayed out of high-tech."
Small but consistent
NorthPointe has an office of 10 people, Mr. Petherick said. Among them are Managing Director Michael P. Hayden, Portfolio Manager Peter J. Cahill, Research Director Stephen E. Roberts and Equity Analyst Brian R. Wall. Everyone except Mr. Wall formerly worked at Loomis Sayles.
NorthPointe's goal, Mr. Petherick said, is performance consistency, not necessarily getting top-decile performance each quarter. He and Ms. Champagne would rather see the fund produce consistent returns in the middle of the pack than be at the top of the pile one quarter and the bottom the next.
NorthPointe uses as its benchmark the Russell 2000 stock index. As of Sept. 30, NorthPointe's small-cap value fund was outperforming that index by about 20 percentage points. Institutions, Mr. Petherick said, tend to compare NorthPointe to the Russell 2000 value index, which NorthPointe was outperforming as of Sept. 30 by about 12 percentage points.
"Sustainable, consistent performance is more easily manageable and provides a more consistent and believable return over a long period of time," Mr. Petherick said.
NorthPointe looks at discounted cash flow, profit and earnings growth potential, price momentum and potential earnings surprises.
What they're looking for are stocks that have proven money-making power and potential for annual growth in the 14% to 17% range, but that currently are undervalued by the market. Stocks in NorthPointe's portfolios typically have price-to-earnings ratios below the market, Mr. Petherick said.
"Small-cap value is one of the most inefficient places in the market," Ms. Champagne said. "It affords you the ability to do a little bit of extra work and get good values. Hopefully you pick good stocks that get revalued by the market. There's lots of cheap stocks out there, but you have to pick ones that will be revalued."
Another key is knowing when to hold stocks until their value fully blooms and then discarding them before it wilts - or becomes a growth stock, Mr. Petherick said.
Through September, value managers accounted for seven of the top 15 managed equity accounts, according to PIPER. Mr. Petherick said he sees a continuing comeback for value stocks in 2001 in what he predicts will be a smoother market.