3 Small Value Funds That Buck the Trend

NEW YORK (TheStreet) -- Seeking safety, investors have been dumping shaky small stocks and shifting to giant blue chips. That has hurt small value funds, which have dropped 10.9% this year, trailing the S&P 500 by almost eight percentage points, according to Morningstar.

But not all small value funds have been pummeled. A few little-known managers have managed to stay ahead of the pack. The winning funds include Adirondack Small Cap ( ADKSX), Homestead Small-Company Stock ( HSCSX), SouthernSun Small Cap ( SSSFX).

The top funds emphasize companies with sound balance sheets and strong cash flows. Such stocks have proved resilient lately.

"Our types of businesses have done relatively well during the volatile markets of the past couple years," says Michael Cook, portfolio manager of SouthernSun.

Cook has delivered solid returns by favoring companies that rely on competitive advantages to dominate niches. Most often the strategy has worked. The fund returned 7.9% annually during the past five years and outdid 99% of peers.

A diehard value investor, Cook looks for solid businesses that have been ignored by the markets. When the economy tanked in 2008, many of his holdings were slammed along with their competitors. But as the markets began to recover in 2009, Cook's steady choices rebounded smartly.

A favorite holding is AGCO ( AGCO), a leading maker of tractors. In the most recent quarter, revenue increased 35%, but the stock sells for a modest price-earnings ratio of 11. Sales are growing rapidly in Latin America, a region where farmers are increasing their acreage. Cook says that AGCO dominates the fast-growing markets in Brazil.

"They have a phenomenal dealer network throughout Latin America," he says. Another holding is Middleby ( MIDD), which makes cooking equipment for KFC, Starbucks and other chains. The shares have suffered in recent months as investors worried that restaurant sales would languish if the economy declines. But Cook argues the company stands to continue growing as American chains expand in the emerging markets.

Homestead Small-Company Stock

Homestead Small-Company Stock looks for companies that have fallen out of favor because of temporary problems or cyclical downturns. During the past five years, the fund returned 5.4% annually and outdid 98% of peers. Portfolio manager Peter Morris often buys cyclical companies when the economy is weak and sells them during market rebounds. Lately he has been focusing on industrial companies. Those have been slammed in recent months as investors worried that the economy would sink into recession.

A holding is Westlake Chemical ( WLK), which produces commodity chemicals. The stock slipped from around 65 in May to 41 now. Morris says that the decline has been excessive. The company has been pushing through price increases and the stock should climb when the economic outlook improves.

"The shares can be cut in half during a downturn, and then they double or triple during a rebound," says Morris.

Morris also likes Applied Industrial Technologies ( AIT), a Cleveland-based distributor of bearings, lubricants and other products used by manufacturers. Morris says that the company's earnings rise and fall along with the Midwestern industrial sector. Homestead has owned the stock on and off for the past decade. Morris likes to buy the shares when they sell for less than book value.

"This is a solid company with very little debt," he says.

Adirondack Small Cap

Adirondack Small Cap looks for unloved companies that are improving their competitive positions. During the past five years, the fund has returned 4.8% annually, outdoing 94% of peers. To find bargains, portfolio manager Matthew Reiner often buys former growth stars that have fallen on harder times.

"We will take companies that grow slowly as long as they are profitable and have strong cash flows," he says.

A holding is Smart Balance ( SMBL), a maker of buttery spreads. Several years ago the stock was a darling of growth managers. But sales softened after Wal-Mart ( WMT) introduced its own competing brand. Reiner says that Smart Balance is rebounding. "They are starting to improve their competitive position by rolling out a value brand," he says.

He also owns LSI Industries ( LYTS), which supplies energy-efficient lighting to gas stations and convenience stores. Gas stations can achieve substantial savings by replacing old-fashioned fluorescent bulbs with new LED systems. Reiner says that LSI is in a dynamic niche that should continue growing.

Stan Luxenberg is a freelance writer specializing in mutual funds and investing. He was executive editor of Individual Investor magazine.

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