Small-capitalization stock managers far outdistanced other equity management styles for the quarter and six months ended June 30, according to the Pensions & Investments Performance Evaluation Report.
Market watchers expect small caps to continue to perform well in the face of increasing market volatility.
Small-cap managers were the best performers overall in both the PIPER managed accounts and commingled funds for the quarter and the six months.
The median small-cap manager of PIPER managed accounts was up 7% for the quarter and 12.8% for the six months, while the median overall equity managed account manager was up 4.3% and 10.4%.
The median PIPER commingled small-cap manager returned an impressive 6.8% and 12.5% for the same time periods. The median overall equity PIPER commingled manager, however, returned 4.5% and 10.2%, for the respective periods.
Small stocks lead market
According to the Frank Russell Co., Tacoma, Wash., small stocks led the broad stock market average to its sixth consecutive quarterly advance. According to Russell, small stocks jumped out to a five-percentage-point lead over larger stocks early in the second quarter, only to give it back up in June. By the end of the quarter, small stocks had outperformed large stocks by about one percentage point.
The Russell 1000 Index, which measures large company stock performance, returned 4.08% for the second quarter; the Russell 2000 index of small-company stocks returned 5%. For the first six months, the Russell 1000 was up 9.8%, while the Russell 2000 was up 10.36%.
The Standard & Poor's 500 Stock Index was up 4.49% in the second quarter and 10.1% in the first half.
Oppenheimer Capital finished first among the top 10 equity managers overall in the PIPER managed account universe for the quarter with 23.7% and sixth overall for the 12 months with 63.94% for their concentrated value equity style portfolio.
Technology rebounds strong
Apodaca-Johnston Inc., San Francisco, was second among overall equity managed account managers for the quarter, with a 21.23% return in its small-cap equity growth style; fourth for the five-year period with 34.79%; second for the 10 years, with 25.69%. All returns of more than one year are compound-annualized.
Apodaca-Johnston also finished in the top spot among PIPER growth stock managers for the second quarter.)
Scott Johnston, chief investment officer at Apodaca-Johnston, said the firm's small-cap portfolio has a 50% allocation to technology stocks and another 25% to the health care sector. The average capitalization of companies in the portfolio is about $250 million.
He said technology stocks staged a strong comeback in the second quarter after the "debacle" in the first three months of 1996, "so we were in the right sector."
The portfolio had most of its technology exposure in telecommunications equipment and computer software; none of its holdings was in the slipping semiconductor industry.
"Our goal is to find and have companies with limited sponsorship and limited institutional ownership," he said.
He said the small-cap growth approach has worked well, with the average reported earnings growth for 66 companies in the firm's portfolio coming in at about 91% during the past 12 months. The firm projects estimated earnings growth averaging 62% in 1996 and 68% in 1997, he said.
"We look for companies with large acceleration in their earn-ings and sales," said Mr. Johnston. "The average growth rate annualized over the past five years has been 14%."
Some of the prominent names in the Apodaca-Johnston portfolio include Van's Inc., Viasoft Co., Reno Air Inc., Rational Software Inc., Pediatrix Medical Group and Pcom Inc.
"We look for companies with big explosions in earnings that are relatively undiscovered and have exciting products. It is a disciplined approach which I have developed over the last 20 years," said Mr. Johnston.
Apodaca-Johnston has about $520 million under management for 21 clients.
A portfolio of winners
ABB Investment Management, Stamford, Conn., finished the quarter third overall among PIPER managed account managers with 19.38% and first for the year with a whopping 87.03%.
John Parsons, ABB small-cap portfolio manager, said none of the approximately 50 stocks in the portfolio was hurt during the 12-month period; in fact, most of the major positions in the portfolio had positive overall returns - even though upwards of 20% of the portfolio is involved in the technology sector.
He said the portfolio is made up of small-cap growth stocks from $100 million to $1.5 billion in capitalization, with $500 million being the average, that are growing at a rate of 20% or more each year. He said the firm follows a "totally bottom-up" investment approach and avoids commodities and utility stocks.
Significant holdings in the portfolio include Youth Services International Inc., ATC Communications Inc. and CDI Corp.
Mr. Parsons said he looks for the small-cap sector to continue to do well, even in the face of growing market uneasiness.
"In looking at the most attractive stocks, I still think that it will be the small-cap area," he said.
"At the beginning of the year we were finding a lot of good stocks, but by May it had become more difficult. Now (after the recent correction) we see some of these stocks being more reasonably priced again. There was a serious panic in July with wild swings in some stocks 50% up and down and there was some big money coming into the small-cap area, all trying to squeeze into a narrow door," he said.
"This correction has come and gone and may have actually strengthened the market."
Right place at right time
On the PIPER commingled side, Munder Capital Management finished first overall for the quarter with 13.21% for its small company growth fund and fourth overall for the year with 50.03%.
TCW Group, Los Angeles, finished first overall for the year among PIPER overall equity commingled funds with 69.45% in its small-cap growth fund and sixth for the quarter with 10.89%. TCW finished No. 1 for the three- and five-year periods and second for the 10 years ended June 30 with 34.84%, 30.89% and 20.71% respectively.
Charles Larson, one of three portfolio managers for the TCW small-cap growth fund, said TCW through the years has made a "major commitment" to the small-cap area and now runs about $900 million in small-cap stocks, of which about $150 million is in the commingled fund.
Mr. Larson said TCW focuses on companies with capitalizations of $1 billion or less, with the average being about $500 million. "But we don't sell because a company gets to $1 billion," he added.
"I'd suppose that recently what we have done is been in the right place at the right time. But we also know this market, and we have people doing extensive research and analysis. We use a consistent approach and we don't try to market-time. We realize there will be market setbacks, and we don't worry too much about interest rates or inflation. We are bottom-up investors," he said.
As such, TCW uses a "very research-intensive process" and tries to focus on "company-specific issues" and to position the portfolio in companies with improving fundamentals, above-average growth "and companies we believe will surprise Wall Street with upside earnings surprises."
Mr. Larson said TCW's portfolio contains the same kinds of stocks valued by many growth investors - a fair amount of health care, technology and leisure and retail issues. The portfolio has been carrying nearly one-third technology stocks centered on companies "with a well-defined product niche, and not too many semiconductor companies."
Some major positions in the TCW small-cap portfolio include Dura Pharmaceuticals Inc., Orthodontic Centers of America Inc., Corrections Corp. of America, Cascade Communications Inc. and Ascend Communications.
Mr. Larson said he is confident small-capitalization stocks will continue to do well in coming months largely because of their earnings strength.
"Small-cap stocks will never carry the market; if the big guys are going down, the little guys, being less liquid, are going to be hurt worse," he said.
"But we believe small companies have better growth prospects and are selling at lower p/e multiples now, based on earnings, than large companies."
He said the streak of stock market volatility that characterized the domestic stock market in July was "just a rough spot in the road."
"We had an awfully strong stock market for the past 18 months; this was a normal correction," he said.
Revenue, not capitalization
The American Express Trust Emerging Growth fund, a $65 million collective trust and part of the larger $1.8 billion Growth Spectrum Advisors at American Express Institutional Retirement Services, Minneapolis, placed in the top 10 PIPER commingled funds for all periods ended June 30. The small and midsized company aggressive growth stock fund was second overall for the quarter with 12.81%; third for the year with 53.73%; fourth for the three-year period with 24.91%; fourth for the five-year period, 26.31% and seventh for the 10 years, 16.77%.
Gordon Fines, senior portfolio manager, said the fund uses a revenue test to screen stock candidates.
"We look for revenue of less than $600 million with demonstrated earnings growth of 20% or higher," said Mr. Fines. "The revenue test, we believe, is a better reflection of how large or small a company really is. Capitalization is more an expectation of pessimism or optimism."
Mr. Fines said the fund's largest position was in technology stocks "and continues to be." He said the technology stocks are centered around networking, telecommunications and software companies. In addition the portfolio contains a significant allocation to the energy sector.
Major portfolio holdings include H.B. Owen & Co. and Cisco Systems Inc.
Mr. Fines said the recent market volatility may be a sign of things to come for the stock market.
"There has been a lot of volatility out there, and we are not finished yet; it's been a roller coaster and it wouldn't surprise me if we see another downdraft in the market," he said. The market could move in a "sawtooth pattern" for the balance of this year "or even longer."
Market uncertainty could last until well beyond the new year.
"A new presidential term usually is a difficult period for the stock market, so we look for continued volatility," he said.
"In the meantime, we will focus on the best growth at hopefully reasonable prices, get to know our situations well and stay with them. Let your winners run and get rid of the losers," he said.
Energy bounces back
Energy stocks have not been among the best performing sectors in several quarters, but staged a comeback in the second quarter.
State Street Research & Management Co.'s energy stock portfolio ended the second quarter in fourth place overall among PIPER managed accounts with 18.21%.
Daniel J. Rice, portfolio manager for the $600 million portfolio, said he uses a combination of top-down and bottom-up stock selection processes.
He said his portfolio was helped dramatically when three of the top 11 holdings became the target of buy-outs and tendered their outstanding stock at a premium. The three were Phoenix Resources Inc., Enserch Corp., and Landmark Graphics Inc. Each was the recipient of a 40% to 70% premium over stock value prior to the buy-out or takeover.
Mr. Rice said most of his stocks have an average capitalization of $300 million. The portfolio has three main themes - natural gas, oil field services and companies with international development capabilities.
The long-term outlook for the energy sector is positive given the anticipated increase in natural gas prices, but, more significantly, increasing energy demand in developing countries, he said.
"Demand in some developing countries is becoming a much bigger part of the world economy. At some point that demand is going to outstrip available (energy) supplies; it's a pretty good environment," he said.
PIPER data is compiled by Rogers, Casey & Associates Inc., Darien, Conn.