10 Questions With Forward Hoover Small Cap Fund's Irene Hoover

Personal Finance takes center stage as mutual-fund reporter Ilana Polyak chats live with Faraz Naqvi, co-manager of the Dresdner RCM Biotech Fund and the Dresdner RCM Global Health Care fund. Have your questions ready for this exclusive free chat on TheStreet.com Tuesday August 8 at 5 p.m. EDT.

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Perhaps Warren Buffett should take a page from Irene Hoover's book.

Like the Sage of Omaha, Hoover, the portfolio manager of the (FFSCX Quote)Forward Hoover Small Cap fund, shied away from technology. Since setting up shop with the Forward Funds of San Francisco in October 1998, Hoover stuck to the sectors she knew: financials and retail. Those moves put her out of the tech rally throughout last year. She lagged most of her small-cap blend peers, who invest in stocks with less than $1.5 billion in market capitalization, during the fund's first year of operation.

But she got into tech stocks in a big (but smart) way at the end of 1999. The former portfolio manager of the (JVMCX Quote)Jurika & Voyles Small Cap offering dived into the sector, raising her allocation to close to 40% at one point before paring back to about 20%. It's paid off: Her fund so far this year is outpacing more than 80% of its peers.

Even so, you could hardly describe Hoover as a go-go growth investor. True, her top six holdings are in technology, but she also likes Old Economy stalwarts such as AnnTaylor(ANN Quote) and Williams-Sonoma(WSM Quote).

Irene Hoover
Fund (FFSCX Quote)Forward Hoover Small Cap Equity
Managing Fund Since Oct. 1, 1998 (inception)
Asset Size $77 million
1-Year Return/Rank in Category 15.2% / 332 of 551
Load/Annual Expense Ratio None / 1.45%
Top Holdings Avocent (AVCT Quote) GaSonics International (GSNX Quote) Titan (TTN Quote)
Source: Lipper, Morningstar, ForwardFunds. Returns through Aug. 2. Holdings through June 30.

1. Small-capitalization stocks have been on a tear relative to large-caps. Why?

Hoover: Well, our portfolio is almost an example of one of the reasons: Many buyouts are occurring in the small-cap area, especially of companies that are undervalued. They're strategic buys. Within the last two months, we had three buyouts.

Also, the earnings growth of small-caps almost collapsed in the second quarter of 1998. That was at the same time that earnings growth of larger companies like Cisco(CSCO Quote) were really accelerating, with huge earnings surprises. The disparity on the earnings growth outlook for the small-caps and the large-caps became huge.

Now that has narrowed, where the small-cap earnings estimates on the Russell 2000 [which tracks small-cap stocks] are essentially estimated at the same rate as the growth for the S&P 500 [which tracks larger companies]. So I think earnings are beginning to come back in the small-cap area.

A third reason for the strength is that you have the tremendously cheap valuation vs. the large-cap stocks, really as cheap as the valuations ever get. They're cheaper on a price-to-book, price-to-cash flow, price-to-earnings compared with the large-cap stocks than they've ever been. Meantime, you have earnings growth improving. That's a formula for better performance in the stock market.

Now, there's a caveat: If the market gets extremely volatile, investors start worrying about liquidity. There's more illiquidity in the small-cap area, so that could cause people to pull back from small-caps.

2. You recently bumped up the amount of technology you have in your fund. Why did you stay out of technology so long, and why are you in now?

Hoover: I came into technology in the fourth quarter of last year because when you looked around the rest of the economy, it was difficult to find sectors that had the type of real growth that the technology sector had. In some of the other sectors -- manufacturing, industrial, broad-based areas, even in finance, small-cap area -- you had special-situation companies that had worked in the past, and many of those are consolidators in their industries. Whereas the actual sector or the industry itself was only growing in line with GNP or GDP, it didn't have a lot of top-line growth in the sector, in the industry.

So we decided to take some more technology into the portfolio because that was where there was real growth.

We have a stake in the low-20% range at this point. We had stayed away from it, waiting until we figured out what was going to happen with Y2K. And so then we bought in the semiconductor and semiconductor capital equipment area for the most part, and some special situations. But then the stocks ran up, got very, very overvalued in the middle of the first quarter and we cut our weighting back to 20% in April.

Then they ran up again and got to over 30%. And now we've cut them back again and actually now, with the technology pullback that's happening currently, we're looking to add a little bit in here. But we're probably going to keep it more or less market-weighted from here on out.

3. What areas look good to you right now?

Hoover: I still think the semiconductor area in certain cases, when they're supplying to the infrastructure build-out and have long visibility, almost all the way through 2001, such as Cypress Semiconductor(CY Quote) and Integrated Device Technology(IDTI Quote), those would be the two that I'd be looking to add to.

4. So as you were taking on more technology, what were you selling in the portfolio? What had to go?

Hoover: We did lower our consumer weighting in the fourth quarter in order to take on the technology. We had been as high as over 35% in the consumer area and we set price targets when we go in, which are based on our projected earnings 18 months out and one times the growth rate.

We have been rather light in the consumer arena, because with the increase in interest rates, we're kind of waiting for that to be over. Then, we think, the Street will return to the retail area.

As far as the retailers and the consumer area, we cut back our weighting. Right now, we're only around 20%. But we did add to them, in February and March, when the retailers became very oversold, in particular Ann Taylor. We also initiated a position in Ross Stores(ROST Quote). Now, Ross Stores is about back down at our purchase price; we really haven't made a lot of money there, but Ann Taylor has done well. It's a company that's growing its earnings at over a 20% rate and it had gotten down to where it was really selling at three times after-tax cash flow.

We also had bought Lands' End(LE Quote) in the mid-20s. When the stock got up to over 50, we took our profits, because we thought it was ahead of itself.

And we actually did buy Lands' End again in the first quarter, because then the stock went right back down to the low 30s and we thought it was attractive again. It ran up on really just fluff in a certain sense -- on the basis of its Web page and the newer catalog. But we're out of Lands' End now because we were concerned about some of the fundamentals.

5. Utilities make up a pretty big portion of your portfolio. What do you like among that group?

Hoover: I'm a believer in the energy area. That's an area we really went into in early '99. At that time, the stocks were out of favor because they had had such a poor '98 as a result of the price of oil and gas dropping so dramatically after the Asian crisis. We bought some positions and then as they've gone up, they've grown as a percentage in the portfolio.

During this quarter, they got to over 20%. We've cut that back now down to the mid-teens, low to mid-teens, because some of the stocks have made huge runs. We're still there and we like quite a few of them and think that particularly those related to natural gas will continue to do well.

I think the rally in energy is sustainable. I don't think the oil prices are sustainable at 30, but I don't think the market's been giving the stocks credit for 30. Because everyone knows that if oil stays above 20 to 25, that's really what we need in order to keep the oil companies spending, the large majors, spending on exploration, and then that will benefit the oil service companies.

With all the increase in drilling rigs, we haven't had a big increase in production yet. So I think that there's another leg in these energy, especially gas-oriented, companies.

6. What are some of the stocks you like in the energy sector?

Hoover: We like Barrett Resources(BRR Quote), Forest Oil(FST Quote). Grant Prideco(GRP Quote), which is an energy-service company. We also like Nabors Industries(NBR Quote) and UTI Energy(UTI Quote), which are land drillers here in the U.S. So we're going to stay there for the long term.

7. What's your outlook on interest rates, and how is it affecting the stocks you're buying now?

Hoover: Interest rates have gone up quite a bit and we're probably getting to the end of the hikes, at least in the short run. I think we'll just have to wait and see. We're toward the end of the increases, I think, and over the next six to nine months, we'll probably get clarity as to when that actually is going to end.

We've stayed away for the most part and have had a lower-than-index weighting on the financial services until we see some clarity on interest rates. We're getting more interested there. We've actually added a couple of financials, more or less along our theme of financial services for the individual investor.

We have Silicon Valley Bancshares(SIVB Quote), which is really not financial services for the individual investor. It's a bank here in California for start-up companies and they're very systematic and risk-averse in how they do it.

We have Greater Bay Bancorp(GBBK Quote), which is another California-based bank, which has been benefiting from strong growth in the San Francisco Bay area.

We also have Legg Mason(LM Quote), which is a brokerage and asset-management firm. We think it's a long-term candidate for a buyout. They're growing their asset management as a percentage of their revenue and they continue to do that.

8. Part of your investing strategy is based on detecting broader demographic themes and seeing which companies are well-positioned for growth. What themes are you interested in these days?

Hoover: I think the baby boomers and the demographic push in this area is going to go on for another 10 years.

We still like the theme of financial services for the individual investor. Initially, when I started liking this theme, which was really back in 1988, I was on the sell side and recommended Charles Schwab(SCH Quote). That has become a huge-cap stock. It really was a leader in providing financial services for the individual investor. Now we have pulled back to where we really are isolating regional brokerage firms and smaller money managers.

Among other themes, as far as the Internet and the telecommunications area, we think this infrastructure building is going to continue. That's how we're trying to position in the technology area, to find suppliers that can be evaluated on the basis of earnings and earnings growth and cash-flow generation.

In the retail area, we like consumer products for a healthy lifestyle. That was how we got into Celestial Seasonings [which is now part of Hain Celestial Group(HAIN Quote) after Hain Food Group's May acquisition]. Whole Foods(WFMI Quote), which is a retailer, is another one of our holdings which is along those lines.

9. If you had to buy three stocks now and hold them for five years, what would they be?

Hoover: Barrett Resources is a very good energy company. I think maybe either Cypress or Integrated Device over a five-year period have a very good outlook. I'd take Integrated Device for its role in supplying to the infrastructure build-out for the telecom area. And I think this is going to be a growth area for many years.

Their stock is way down now, so it's at a good point to enter.

10. What was the last stock you bought for the fund?

Hoover: Well, I can't tell you the most recent, because I'm still buying it.

SkyWest(SKYW Quote) we bought recently. It's a regional airline we bought a few weeks ago.

It's a feeder airline for Delta(DAL Quote) and United [owned by UAL(UAL Quote)] and they're going to be transferring from propeller planes to jets and expanding their fleet dramatically over the next three years.

I think it's a really long-term growth story. On the fuel side, they have agreements to fix the price of fuel, so they're not really whipped around by the changing value of fuel, which I think is a positive. And there are some agreements that they have to work out with United which are really holding the price down. Once those are concluded, they can go ahead and start adding these regional jets. We think it has an opportunity to grow with both airlines, Delta and United.

We bought it in the mid-30s.