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February 18, 2002 12:00 AM

Managers find varying paths to success

Equities: Value styles in small and midcap portfolios take honors' signs of life in growth

Ricki Fulman
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    Small-cap and midcap value strategies were the big equity winners for 2001 in both the managed account and commingled universes of Pensions & Investments' Performance Evaluation Report, but some small-cap growth strategies staged a recovery in the fourth quarter as the stock market rallied.

    The Boston Co. Asset Management LLC, Boston, topped the rankings for the year in commingled accounts with its small-cap value equity fund, which returned 36.5%, followed by its Select Value Equity Management fund, which gained 32.2%. Reich & Tang Capital Management, New York, placed third with its small-cap value fund, up 31%.

    The Boston Co.'s select value fund took the lead in the fourth quarter, returning 44.6%, and its small-cap value fund was up 42%. TCW Group, Los Angeles, ranked third for its small cap growth equity fund, up 41%.

    In managed accounts, Charlotte Capital LLC, Charlotte, N.C., ranked first for the year for its small/midcap value approach, up 58.6%, and third for its small-cap value exempt strategy, up 51.1%. Boston Partners Asset Management LP, Boston, was second with its Small Cap Value Equity II portfolio, up 51.2%.

    In the fourth quarter, Amerindo Investment Advisors Inc., New York, trounced the managed account competition with its emerging growth strategy, which gained 71.4%. Boston Co.'s Select Value Equity Management account, up 44.3% ranked second, followed by the science and technology strategy of McKinley Capital Management Inc., Anchorage, Alaska, which gained 42% in the period.

    In comparison, the Russell 2000 index was up 21.1% in the quarter, and 2.49% for the year; and the Russell 2000 Value index was up 16.7% in the quarter, and 14% for the year.

    Most of the Boston Co.'s strong showing really came in the fourth quarter, said Corey Griffin, managing director. He noted the portfolio managers found a lot of companies on sale late in the summer and even more after Sept. 11.

    "We were able to buy quality names on the cheap," said Mr. Griffin. "We're stock pickers, and to be selected for our portfolios, a stock has to be cheap and beaten down regardless of the sector it represents. We do bottom-up stock selection, using a variety of approaches: price to earnings, price to sales, cash flow, cash on balance sheets, breakup value and so forth."

    In the fourth quarter, consumer services, particularly specialty retailers, was the sector offering the best buying opportunities, he added.

    The firm used the approach for both of its top-ranked portfolios. The difference between the small-cap value and select value portfolios is in market cap, with the stocks in the small-cap folder capitalized at $100 million to $1.5 billion while the select value stocks are capitalized at $2 billion and more.

    He declined to provide the names of favorite stocks in the portfolios.

    Reich & Tang, whose small-cap value equity fund gained 31% for the year, also was able to buy a lot of excellent businesses at depressed prices last year.

    "We were able to avoid mistakes, so we didn't have to offset our gains with losses," said Steve Wilson, chief investment officer: "We had few down stocks. Around 85% were up and 30% to 40% had exceptional returns."

    The portfolio is concentrated in about 40 companies, with 10 of them making up 35% to 40% of the portfolio. "We don't look at sectors, but invest in superior businesses that fall between the cracks. We never bought Internet companies because we want established companies with good market share, high returns and managers who know how to run their business," he said. "A number of the companies we owned for a couple of years bounced around, but finally did well in 2001.We try to buy companies as value stocks and sell them after they become growth stocks."

    Stocks that have done well include Ball Corp., the largest North American manufacturer of beverage containers; and Harman International Industries Inc., which makes audio systems for cars.

    Bucking the value trend was TCW's small-cap growth strategy, which placed third for the quarter in the commingled equity accounts.

    "We focused on small, rapidly growing growth stock with higher price-earnings ratios," said Doug Foreman, co-manager of the small-cap group. "We had been getting hammered through September but started to see some recovery in the fourth quarter. The market had discounted growth stocks in advance of the recovery which began then."

    He looks for companies with a p-e of 35 times 2003 earnings, noting that using short-term earnings during a recession is not very useful. The fund is overweighted in technology and also includes selected specialty retailer, media and biotech companies. Quest Software Inc., Micrel Inc. and Siebel Systems Inc. were among its top performers.

    In the managed accounts universe, Charlotte Capital placed first and third by focusing on deep value, said Ronald Saba, chief investment officer.

    "We buy low expectation stocks that other people have thrown out," he said. "We look for companies that have been undersold on the downside, with low price-earnings ratios, low price-to-cash flow, low price-to-book or -sales. ... It could be any of those, but we're very big on cash flow."

    The firm looks at businesses that have underperformed for one to three years and have some activity such as a new management team, or insider buying, he said.

    "We do a lot of work to be sure the stock isn't going to trade any lower, and that all the downside risk has been squeezed out. We then determine what it may be worth, how long it will take to get it to that price. We usually want it to happen over an 18- to 24-month period. If there is a new management team, we get to know them and try to determine how they will make money. We also look for a catalyst that is going to push a stock price higher."

    Both portfolios use the same investment process, but the small/midcap value account invests in companies capitalized from $500 million to $5 billion; the small-cap value exempt invests in companies with market caps of $100 million to $1.5 billion. Stocks that did well included Storage Technology Corp; Great Atlantic & Pacific Tea; and RPM Inc.

    The success of small-cap value strategies last year contributed to the strong results at Boston Partners' funds, said David Dabora, portfolio manager and principal.

    Like Charlotte Capital, managers of Boston Partners' Small Cap Value Equity II portfolio also look for a catalyst that will unlock the value in a company, such as new management or changes that will boost company performance. "We also look for companies that will grow and be profitable," said Mr. Dabora. The portfolio has more than 160 stocks; 120 of which were up more than 20% during the past year. Outperformers included Network Associates Inc., Sola International Inc., Stewart Enterprises Inc. and Pier 1 Imports Inc.

    Amerindo's growth portfolio staged a comeback in the fourth quarter in the managed accounts universe. "Emerging technology stocks rose a lot in the quarter," said Michael Sandifer, a member of the investment committee.

    Much of the gain was due to a rally where many tech stocks had been oversold, he explained. "We concentrate on what's new and innovative in technology, and focus on themes rather than specific sectors."

    Themes that Amerindo likes now include the convergence of computing and communications in the Internet "because we're in an era when people are combining these for instant communication," Mr. Sandifer said. "Storage is also important as we rebuild the telecom infrastructure through pockets of information. Applications of software packages could become passe if they're not designed around Internet usage."

    Among stocks that he likes are eBay Inc., which is now used by many companies as a site for their businesses, and Freemarkets Inc., a business-to-business "e-marketplace" which is becoming important for business transactions.

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