Keeley Fund Digs Deep for Winners

The small-cap value fund has easily outpaced the big-market indices this year.
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It has been a tough year for fund managers trying to drill for undervalued companies -- beyond the oil patch, anyway.

One fund, however, has a long history of unearthing winners where others fear to dig. It's the


Keeley Small-Cap Value fund. The fund has amassed an impressive annualized 10-year return of 15.14% through its strategy of investing in corporate spinoffs, companies emerging from bankruptcy, bank conversions and other niches traditionally shunned by Wall Street.

This year the fund is up 14.23%, which is over 11 percentage points better than the

S&P 500


sat down with the fund's vice president, Mark Keeley, to learn how the fund's managers make their choices -- and to find out where the fund is headed next.


Your fund has reacted well in what has been a very confusing year for fund managers, mostly over the strength of the economy. How does the slowing economy affect your fund's unique strategy?


: It gives us more names to look at, actually. Take corporate spinoffs, for example, which is our largest area. When revenues slow down, bigger companies are forced to unlock shareholder value in other ways. One potential method is through the divestiture of divisions that have the potential to do well on their own.

It's not that recent, but a great example for us was

Procter & Gamble's

(PG) - Get Report

spinoff of

J.M. Smucker

(SJM) - Get Report

. After Smucker was spun off, they turned around and cleverly purchased two of P&G's well-known brands, Crisco cooking oil and Jif peanut butter. So, analytical geniuses that we are, we saw real synergies in a company that produces both peanut butter and jelly. Makes sense, right?

In truth, the company has done a great job developing its brands, and that's been reflected in the stock price. The company was originally spun off in 2000 at around $20 and is now trading in the mid-$40s.

That's a high-profile example, though. We generally look at smaller companies. One of our favorites now is the homebuilder



, which had a long history building homes in the Northeast until it was acquired and then spun off from


(BBX) - Get Report


Most fund managers avoid companies emerging from bankruptcy, but your fund seeks them out. How do you make sure the company won't go down for a second time?

We don't buy stocks on the way down with the hopes they won't file. We only invest in the new equity of companies that have recently emerged from bankruptcy. We look to see if the brand is intact and if there is a new management team. We also look for a big tax loss carry-forward, which is an advantage that is often overlooked.

Do you invest in airlines? There have been plenty of airlines flying in and out of bankruptcy lately.

Airlines are much bigger than what we normally look at and they have too many moving parts. We like to keep it small so we can understand the accounting and industry-specific issues. A lot of these are not very exciting companies, but they are good opportunities.

You also invest in savings-and-loan conversions? How do you do that? Do you travel around the country opening small passbook accounts in local banks and wait for the IPOs?

No, that's the traditional way. We wait for them to go public and then try and pick up shares after the first wave of sellers exits. If we can, we try and pick these bank shares up close to book value. We might be a little over or a little under, but, on average, most of them wind up getting taken over for around 2 times book value, so it's a great opportunity.

Are there still a lot of companies trading at book value or below out there?

Not as many as you would think, but that's a function of accounting as well. We use a proprietary system for calculating book value since it can often be overstated or understated on a balance sheet. It's a question of accounting sometimes. One name we like is

Providence & Worcester Railroad


. These guys have land on their books that goes back over 150 years. It trades at less than $11 and the book value is over $15 a share.

Your fund owns over 100 different companies. That seems like a lot for a fund with your size and style. Do you meet with the executives of all these companies or do you rely on Street research?

We do our own homework. And since we are long-term holders as opposed to noisy shareholder activists, company management is more often than not motivated to see us. We are usually the first institutional buyers many spinoffs meet.

What industries are you looking at now?

If you look at the sector breakdown of our fund, we have historically been overweight financials because of our activity in the savings-and-loan area. But lately we have been looking more toward the Rust Belt for opportunities. A lot of times these Rust Belt companies are unfairly avoided, but now they have been awakened by the improving economy.

One good example is

EnPro Industries

(NPO) - Get Report

, which is an industrial material manufacturer spun off from



in 2002. Like a number of companies, they were painted unfairly by the asbestos litigation. Now that the asbestos claims are being thrown out or settled, the stock is popping. The stock was originally spun off at $8 and now it's around $23, so a lot of value was unlocked in that company.

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