It's easy for investors to get wrapped up in the never-ending fight between large-cap and small-cap funds, much like boxing fans have trouble naming the reigning flyweight, featherweight and welterweight champions. From prizefighting to fund-picking, it's just easier to focus on one or two classes. Unfortunately, that narrow style of thinking causes investors to rule out a number of mutual funds simply because of their size. To illustrate how good funds come in all shapes and sizes, here are three off-the-rack funds worth trying on: a mega-cap, a micro-cap and a mid-cap. (And for you boxing fans, I'll list the current fly, feather and welterweight champions at the end of the article, just in case you forgot.)
Giant GainsFor a nation that prides itself on its ability to "super-size" most anything, it seems almost unpatriotic to say there are only seven mega-cap stocks listed on U.S. exchanges. Nevertheless, that's the number that qualifies as being the biggest of the big, a lucky seven that includes British Petroleum ( BP), Citigroup ( C), ExxonMobil ( XOM), General Electric ( GE), Microsoft ( MSFT), Pfizer ( PFE) and Wal-Mart ( WMT). John C. Thompson owns all of these giants, save the ADR British Petroleum, in the $1.4 billion ( THPGX) Thompson Plumb Growth fund. And he's not troubled by holding them in large stakes, either. In a fund of 57 stocks, Microsoft makes up almost 6% of the portfolio and Pfizer close to 5%. GE and ExxonMobil each weigh in at close to 2% of the fund's asset base. In total, the top 10 stocks in the mega-cap fund account for close to 50% of its assets, a fairly concentrated portfolio even if the stocks bear household names. But even though the fund seems top heavy, Thompson's track record demonstrates that he can skillfully navigate the land of the giants. The average market capitalization for the stocks in the portfolio is on par with the S&P 500 at a healthy $45 billion, yet the fund has returned 17.94% annually over the last 10 years, more than 6% better than the S&P 500 over the same period. The fund has beaten the index by 6.32% and 12.49% over the past three and five years.
|Sizing Things Up |
Fund Sizes by Capitalization
|Fund Classification||Market Capitalization|
|Mega-Cap||Greater than $200 billion|
|Large-Cap||$10 billion-$200 billion|
|Mid-Cap||$2 billion-$10 billion|
|Small-Cap||$300 million-$2 billion|
|Micro-Cap||$50 million-$300 million|
Thompson's mastery over the index has earned kudos from Morningstar analyst Langdon Healy, who readily admits that it's tough to garner outsized returns when buying outsized companies. "Historically, most actively managed large-blend funds haven't been able to edge past cheap S&P 500 Index funds," says Healy. "When we give the nod to a manager here, where markets are at their most efficient, we are to some extent going out on a limb. With that as a backdrop, we think this fund is a serious alternative to an S&P 500 index fund." So what's Thompson's secret for hunting Goliaths? Thompson buys quality companies trading at prices at the low end of their 10-year historical price-to-earnings range and sells them when they breach the high end. In other words, the fund looks for companies whose earnings growth might have slowed temporarily but which will regain their momentum further down the road. Thompson offers his recent decision to buy additional shares of Viacom ( VIA) as an example of his contrarian approach. He says the stock is trading at close to 16 times free cash flow -- the most widely used metric for media companies -- when it has been upwards of 40 in the past. Hold on a minute. Scooping up slumping stocks? Striking when multiples are depressed? Buying Viacom? For a fund with "growth" in its title, aren't those classic value manager moves? "Growth investors tend to pay too much for momentum, and value guys have the bad habit of sticking with junky companies too long, hoping things get better," says Thompson, responding to a question frequently asked by investors who would rather he confined himself to a single Morningstar-style box. "Sometimes it makes sense to pay up for quality, and sometimes it doesn't."
|Good Funds Come in All Sizes |
|Fund/Index||Ticker||YTD %||Annualized Returns %||Expense Ratio%|
|3 Year||5 Year||10 Year|
|Thompson Plumb Growth (Mega)||THPGX||0.26||4.70||9.11||17.94||1.07|
|Perritt Micro Cap Opportunities (Micro)||PRCGX||1.99||19.56||18.74||15.65||1.44|
|Meridian Growth Fund (Mid)||MERDX||1.12||8.79||13.38||14.56||1.06|
|Source: Morningstar (Annual returns through 7/19/04)|
Lilliputian DominationNo matter the market cap, investors tend to shovel money at whatever investing style is hot. And in 2003, small-cap funds generated enough heat to spark a fund closing stampede. The average small-cap fund was up 43.94% last year, an impressive return that ultimately caused a slew of fund closings by managers overwhelmed by cash. Out of the 76 mutual funds that have closed to new investors in the past year, 36 were small-caps, according to Morningstar. One fund that thrived while keeping its doors open was the $207 million ( PRCGX) Perritt Micro Cap Opportunities fund. Perritt returned 63.5% in 2003, substantially outperforming both its small-cap peers as well as the S&P 500, which only returned 28.7%. (Micro-cap funds are lumped into the small-cap category for comparison sake at Morningstar.) Michael Corbett, Perritt's manager since 1999, says he will seal his fund to new investors should it hit $300 million, but not because of "a lack of ideas," a common excuse among fund managers with too much cash and nowhere to spend it. "We have plenty of ideas, the problem is that we can't buy any of them," says Corbett, referring to the investment act that forbids a fund from owning 5% or more of a company. "If there is a company with a $100 million market-cap, the most we can buy is $5 million." Corbett could expand the number of companies in his portfolio, but he says the extra names would not be worth the extra effort. He currently holds 146 stocks in his portfolio with an average market cap of $169 million. Corbett gets his investment ideas both internally and externally by soliciting prospects from over 20 research and regional brokerage houses. His strategy is to find tiny companies with attractive fundamentals and favorable growth prospects. The trick in the micro-cap world, says Corbett, is in getting in and out of thinly traded stocks without telegraphing your moves to the rest of the market.
"We leg into a stock, or buy our position directly from a shareholder when possible," says Corbett. "We don't want to rock the boat." Corbett sells his stocks when they don't meet management's expectations or when a company outgrows its micro-cap status. For example, the fund bought Tractor Supply Company ( TSCO) when its market cap was under $400 million and sold it when it broke $1 billion. When he speaks about his Tractor Supply experience, Corbett sounds like a parent who watched a child develop before heading off to college. He says that feeling of entrepreneurialism and growth is what attracts him to the micro-cap world. "Small business is what this country is all about," says Corbett. "Meeting guys that created multimillion dollar businesses in their garages and watching them grow is pretty cool."
A Mid-Cap Fund Fit for GoldilocksIf the stocks in John Thompson's fund are too big for your taste -- or Corbett's too small -- then Richard Aster's $1.2 billion mid-cap ( MERDX) Meridian Growth fund might be just the right size. But not if you are looking for a traditional mid-cap growth fund, the kind whose manager spends freely for growth no matter the price-to-earnings multiple. Aster has been looking for growing mid-cap companies since launching the fund in 1984. Nevertheless, he drives a harder bargain than the majority of growth managers in that he won't overpay for a stock. The average P/E ratio in Aster's fund is 29.82, which trails the average mid-cap growth fund P/E of 31.91, according to Morningstar. While some might call Aster more of a GARP (growth at a reasonable price) than a growth manager, it's tough to quibble with his results. Meridien Growth has returned 14.56% annually over the past 10 years, beating the S&P 500 by 2.74 over the same period. Over the past five years, the fund has returned 13.38%, a whopping 16.76% better than the S&P.
Aster's fund returned 47.9% in 2003, a tough number to top, even in the most positive market environments. But unlike a number of high-profile fund managers, he does not see raising cash as a near-term alternative. "Valuations are not as attractive as a year and a half ago, but my stocks will do better than their cash over the next two years," says Aster. Instead of heading to the sidelines, he remains 98% invested in 50 companies while monitoring 200 prospective names for his next round of bargain hunting. Aster says his patience allows him to wait for his favorite growth stocks to come down to his price range. For example, he kept bar-code manufacturer Symbol Technologies ( SBL) in his sights for five years before he picked up shares on the cheap when an accounting scandal took the stock well below $10. Symbol now trades close to $14 a share. His current favorite pick is Weight Watchers International ( WTW), a company whose shares have been hurt by the low-carb craze. In Aster's opinion, Weight Watchers will benefit once the Atkins and South Beach fads pass and Americans return to more traditional methods for weight loss. Going against the grain even temporarily has never been a problem for Aste. "You don't do well in this business by doing what everybody else is doing." (OK, fight fans. Here are the answers to the boxing trivia question: The current WBC flyweight, featherweight and welterweight champions are Ponsaklek Wonjongkam of Thailand, Injin Chi of Korea and Cory Spinks of the U.S.)