Small-cap stock managers with great track records and the capacity for more assets are becoming so rare that consultants sometimes will relax typical requirements just to place client mandates.
A three-year track record, for example, no longer is the bar. "Five years ago, when small cap was not in vogue, consultants would absolutely have insisted" on such a track record, said John C. Potter, senior portfolio manager at US Bancorp Asset Management's Milwaukee office. Today, however, "they are willing to consider managers with a good two-year record and a very good process," he said.
Mr. Potter co-manages the 2-year-old, $750 million First American Small-Cap Core Fund. It returned 24.47% for the year ended March 31 and an annualized 9.16% for the two-year period.
"Massive flows into small-cap value in particular are closing a lot of small-cap managers' strategies. Consultants are looking for managers with any capacity," he said.
Sheila Noonan, managing director and director of manager research at CRA RogersCasey, Darien, Conn., said that although a three-year track record and tenure are her firm's normal minimum requirements, "we might relax that if we know the person. With small cap, you really will lose candidates every year to lift outs or closed strategies or departures, so we are charged to try to track people and to identify new candidates every year. We will follow managers to new firms and hire them sooner if it's a relationship that we and our clients are comfortable with."
`High hurdle rate'
Dave Comstock, associate at Ennis Knupp + Associates Inc., Chicago, said he would look at managers with tenure and track records shorter than three years, but only under special circumstances. That might mean a lift out of a team from an existing manager or a new firm started by a veteran.
"There's a higher hurdle rate for these managers - a couple of extra meetings, another on-site visit. You need to be able to demonstrate to the client that the manager has a good story, a solid company. But with a lift out, for example, we might fund them right away," Mr. Comstock said.
He generally prefers a three-year record for small-cap managers, compared to a five-year one for large cap, where managers are plentiful. In the small-cap arena, he noted, "if a strategy is still open after five years, you have to wonder if there's a problem."
According to new data from Financial Research Corp., Boston, six of the 10 largest small-cap mutual funds are closed to new investors and the four remaining are getting close to the magic $3 billion asset figure often considered the top limit for small stock funds.
At least 25 small- and micro-cap funds were closed to new investors in the first six months of this year, according to SEC filings reviewed by a unit of Strategic Insight Mutual Fund Research and Consulting Electronic Products Inc., New York.
One that closed is the Bogle RRB Small-Cap Growth Fund, which is less than 2 years old. It is managed by John C. Bogle Jr., founder of Bogle Investment Management LP, Wellesley, Mass. His previous firm, Numeric Investors LP, Cambridge, Mass., also closed two of its mutual funds this spring, the RBB Numeric Small Cap Value Fund and the RBB Numeric Micro Cap Fund. Numeric also intends to close its RBB Numeric Mid Cap Fund when assets reach $200 million (it's at $30 million now) and the RBB Numeric Growth Fund when it reaches $125 million, which has $40 million now.
Other funds recently closed are the T. Rowe Price Small Cap Value Fund, the Boston Partners II Small Cap Value Fund, the BlackRock Small Cap Value Equity Fund, the Oakmark International Small Cap Fund, the Dreyfus Small Cap Value Equity Fund and the TCW Galileo Small Cap Value Fund.
Few strategies open
According to CRA RogersCasey's InvestWorks.com, 17% of the 468 domestic small-cap institutional separate account strategies are closed to new investors.
Among those open, Turner Investment Partners, Berwyn, Pa., has received additional assets since it lured two small-cap core/value managers - Thomas diBella and Kenneth W. Gainey - from Aeltus Investment Management Inc., Hartford, Conn., said President, Stephen J. Kneeley.
"We got the small-cap team six months ago from Aeltus and secured the AIMR stamp for their 8 1/2-year track record. But even with this, you'd normally get put in the penalty box for a year," Mr. Kneeley said. "But we're been getting increased search activity and hires after just six months, primarily because of capacity constraints with other managers."
Some plan sponsors are willing to look at small-cap to midcap managers (known as SMID) when the "bullpen" of pure small-cap managers is not so attractive, Ms. Noonan said. That has greatly benefited LSV Asset Management, Chicago, said Christopher LaCroix, managing director and partner in charge of sales and client service.
The LSV Small/Mid Cap Value Equity strategy will hit its three-year record Aug. 1, but it already has $350 million in assets, with an additional $50 million in commitments from institutional investors, Mr. LaCroix said. The strategy will be closed to new investors when assets reach between $800 million and $1 billion, which is likely to happen within a year, he said.
"If you talked to me five years ago and said this would happen, I would have said you were crazy," he said. "A lot of good small-cap managers are closed, so a number of plan sponsors are moving to SMID ... They treat it like a conservative small-cap mandate, since the larger midcap stocks temper the volatility of the small-cap stocks somewhat."
Sterling Johnston Capital Management LP, San Francisco, a small- and micro-cap manager, didn't experience rapid growth until just recently (it's 5 1/2 years old), said Scott Johnston, CIO.
"It takes about three or four years before consultants begin to take you seriously, even if you're well-known to them. I've been around a long time - I've started three money management firms - but you have to show them about three years of staff stability, a diversity of revenues and of clients. They are worried about the business risk. But once you have their confidence, as long as performance is good, assets can really explode," he said.