And now for something completely different.
What Fund Companies Don't Want You to Know
I Own What?! The Low-Tech Wired Index Fund
Whether they invest in tech stocks or Peruvian bonds, most portfolio managers tend to have an eerily similar spiel. They'll talk about how they've got an exhaustive fundamental research process. How they don't just talk to a company's chief executive, but to her salespeople, competitors, customers and cousins.
So when I called Steve Grant, who has beaten his average peer in each of the past four years running the
Value Line Emerging Opportunities fund to talk about his outlook and picks, that's pretty much what I expected to hear. But that's not what I got.
Most managers who fish in the vast small-cap market, home to thousands of stocks with a
market capitalization south of $1.5 billion, say they and their teams doggedly research tiny companies all day and night, looking for the next
. Steve, on the other hand, uses a technical approach. He doesn't know much about what a company makes or who runs it, but obsesses over its stock chart and trading volume -- a chartist in the vein of our own Gary B. Smith. Whether you're a fan or critic -- and many may be in the latter camp -- it's a viewpoint we don't often hear.
1. What's the case for investing in small-caps today?
The figures I've seen say that small-caps are still about 30% undervalued as compared to large caps, even after their good comparative performance last year. Other research shows that this is a good time in the economic cycle to be in small-caps -- when we're coming out of an economic slowdown.
Why is that?
Talking With: Steve Grant
Fund: Value Line Emerging Opportunities
Managed Since: July 1998
Assets: $60 million
1-Year Return: 7.5%/Beats 89% of Peers
3-Year Return: 23.5%/Beats 91% of Peers
Expense Ratio: 1.46% vs. 1.62% category avg.
Sources: Morningstar. Returns through Jan. 15.
You know, it's really hard to talk about small-caps as a group because they're so diverse. Some of the stocks are sensitive to what's going on in the economy, and some have their own niche where it's really not that important what's going on in the economy.
2. Given that there are thousands of small-cap companies out there, what's your research process? How do you winnow the field?
I start out by being aware of what is the most important thing that drives stocks. Some might say it's earnings; some
say sales. My feeling is that it's people that drive stocks because it's investors and money managers that determine what the price is on a day-to-day basis. So that comes down to a matter of psychology. I take a technical approach to try to figure out where the psychology
on a given stock is right now and where it's going to drive the stock in the future.
Stock charts are a very important tool for me because they can tell me what people are thinking right now and where the money is flowing in and flowing out. ... When I buy stock, I don't have any price target or time holding in mind. I let the stock's performance tell me how long to hold it and when to get out. We have almost 100% turnover per year, so the average holding time is one year or perhaps a bit less.
You may have heard the beauty contest analogy. The key is not to try to pick who I think is the most attractive company or has the best business, but to try to figure out what other people are going to think is the best business in the months ahead.
3. Some might feel a strictly technical approach is superficial. What's your response?
I don't think I can do much better than come back to what I was just saying. It's people
investors that drive stock prices. No one can know all the fundamentals of a particular company. There's always going to be somebody who knows more than you. The best way of getting a look at where the stock is going to be going is to see where that money is going to be flowing.
It's a process that works for us. We're making bets on 350 to 400 stocks at a time, knowing not all of them are going to work out. The ones that don't work out, we try to get out of quickly. The ones that do, we hold on to. The history of the fund has shown that the odds are in our favor. The more bets we place, the higher the probability that we're going to do well overall.
Big Gains From Small Stocks
Sources: Morningstar. Returns through Jan. 15.
4. Given your approach, where are you investing?
The sector where this fund has seen the most changes in the past few years, both up and down, and the sector that drives the performance quite a bit, is technology. About 50% of the fund was in tech back in '99, and in 2000 and 2001 we sold it down to less than the market weight. We were probably down to about 10% in technology at one point. In the past two or three months, we've started to cautiously get back into tech because that's where the money seems to be flowing. That's where the stock charts are telling us to go. But we're still a little bit underweighted in tech relative to the
Russell 2000, where tech is at about 14% now.
5. What led you to start buying tech stocks again and what do you see from here?
I should add that besides the price momentum of stocks, we do look to some extent at the earnings momentum of companies. We've seen in the past that price momentum often leads earnings momentum for a stock, and the price momentum certainly seems to be telling us, at least in some cases, that earnings momentum is going to be returning in a positive way later this year. We still have not seen earnings momentum return to tech stocks, but we have seen some price momentum return. And some of that has been on very impressive trading volume.
But again, it's certainly very much on a stock-by-stock basis. It's not like I'm trying to make any particular sector bet.
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6. Any fears that you're early?
I don't have a great deal of confidence in where the tech sector is going this year. It certainly still has not proven itself as far as earnings go. That's why I'm still a bit light compared to most of my peers and the Russell 2000.
7. What are a couple of names in the tech sector that you've added to the portfolio?
Lately, we've bought
handheld tech device maker
What sparked your interest in them?
That the psychology was starting to turn better. You can see it in the way the stock was acting and in some of the broker reports from Wall Street. People were getting excited about their new products.
What's another tech stock that you've bought?
Let me take a look at some of my recent purchases. Bear in mind that when I buy stocks, I usually only put about 0.2% of the portfolio in a new holding, so I'm really spreading my bets.
What do those folks do, and what brought you to them?
My computer system is down right now. I really can't say anything intelligent about them at this second. But the key thing, obviously, is that the stock started to move up on very heavy volume.
Crossroads Systems makes routers for storage area networks.
8. On the flip side, what's an area that you're starting to sour on, that you're lightening up on right now?
We were up to maybe 21% in the financial services sector
at one point. Now we're down to 15%, compared to a Russell 2000 weighting of 20%.
The financial services
companies may have had their best days now that interest rates have seen the biggest moves they're going to see. And the price momentum in the sector has flattened out. It's certainly not that I hate the sector, I just don't see the draw right now.
9. If you had to pick a couple of companies on your radar screen that you'd be most comfortable holding for three or five years --
I noticed that you always ask that question. My first thought is that it's very rare for me to hold a stock for five years, so maybe out of the 400 I hold, there will be one or two that I'll have continuously for the next four or five years. I can look at the ones I've held the longest right now.
Two of them are retailers --
Christopher & Banks
. I've held them for about three years, and they keep coming in with performance that beats estimates, and they're store chains with plenty of room to expand and add new stores in the years ahead.
10. Your fund stayed ahead of its average peer in each year from 1998 through 2001 after struggling in years before that. Was there a strategy change?
It was a different lead manager, and he had his own way of doing things. He had middling success, but the process has definitely changed since the first day I took over.
But if you look at Value Line's Web site and Morningstar, there's no indication of a management or strategy change since the fund's 1993 launch.
We advertise all our funds as being managed by a team approach. Are we the only fund that says team-managed? That's the way we choose to show ourselves.
Ian McDonald writes daily for TheStreet.com. In keeping with TSC's editorial policy, he doesn't own or short individual stocks. He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to
firstname.lastname@example.org, but he cannot give specific financial advice.