Thomas Barry, a former Navy fighter pilot, knows a few things about sizing up risk. These days, as manager of the Bjurman, Barry Micro-Cap Growth Fund (BMCFX), Barry sets his sights on stocks of micro-cap outfits that fly below Wall Street's radar. He was recently chosen as the best fund manager in the small-cap growth category in the first annual Standard & Poor's/BusinessWeek Excellence in Fund Management Awards. The fund scored high on S&P's and BusinessWeek's selection criteria, starting with five-year, risk-adjusted total returns and finishing with a qualitative assessment of management and its application of investment discipline.
For the five-year period ended Feb. 28, the Bjurman, Barry Micro-Cap Growth had an average annualized total return of 16.7%, compared with a decline of 4.7% for all small-cap growth funds. The fund ranks No. 3 within this peer group's entire universe of 340 funds and has outrun the Russell 2000 Growth Index in each of the last five years.
Palash Ghosh of S&P's Fund Advisor recently spoke with Barry about investing in the sector and the fund's strategy. Edited excerpts from their conversation follow:
Q: Have you had to change or adjust your investment philosophy in response to the weak global economy and stock market?
A: No. We remain focused on attractively valued, fast-growing, strong companies. This, along with our screening models, never changes. I don't worry a whole a lot about geopolitical issues, but I can say we respond to the poor economic climate by choosing, or getting rid of, individual stocks. This is done purely from a
Q: What are the growth rates like for some of your micro-cap stocks?
A: For the past 12 months our portfolio had a median earnings growth rate of 80%. The micro-cap sector as a whole may indeed have suffered in earnings growth, but the stocks in our fund have not. The forward p-e ratio for our fund is only 15.5, which gives you an idea how the sector remains vastly undervalued.
Q: Given the collapse of larger-cap stocks in recent years, has Wall Street shown more interest in micro-cap companies?
A: No. It's not worth their time because they can't manage enough money in the sector to bother with them. In fact, there are now probably fewer analysts following micro-cap companies, which is good for micro-cap investors like me because micro-cap stocks remain ignored -- and therefore inefficiently priced.
Q: What are your fund's largest sectors or industries?
A: As of Dec. 31, our biggest sectors were electronic technology, 27.1%; health care, 25%; consumer services, 9.5%; finance, 8.1%; retail trade, 7.4%; commercial/industrial services, 6.5%; consumer durables, 4.8%; and producer manufacturing, 3.7%.
Q: Have you recently been adding to technology, your largest sector?
A: Yes. We have been buying more tech positions since late 2002, but this is simply because we're finding very attractive stocks in the sector on a price and earnings basis.
When we talk about micro-cap tech stocks, we mean little companies that have established niche products that dominate their particular industry and have enjoyed strong demand. When the economy finally turns around and investors gain some confidence, the tech sector, regardless of size, will be among the first areas to rebound and outperform.
Q: Your technology allocation was extremely high just before the bubble burst in March, 2000.
A: In late 1999, early 2000, our tech exposure was as high as 70%. Prices in the sector went through the roof, and we got uncomfortable having such high exposure there. We trimmed our tech stake to about 30% by the end of that year. I doubt that we will ever again see a 70% exposure in any sector.
Q: Why is there also high exposure in health care?
A: Like technology, a large number of health-care stocks rank high on our screening models. From a macroeconomic perspective, demographics will continue to benefit health-care outfits. Micro-cap health-care companies, in particular, are coming up with new, cost-effective products that service the larger health-care institutions.
Q: What are the fund's top holdings?
A: At yearend 2002, they were SafeNet (SFNT), 1.7%; Panera Bread (PNRA), 1.7%; Neoware Systems (NWRE), 1.6%; Nam Tai Electronics (NTE), 1.6%; Zoll Medical (ZOLL), 1.6%; OmniVision Technologies (OVTI), 1.5%; PF Chang's China Bistro (PFCB), 1.5%; FTI Consulting (FCN), 1.5%; Websense (WBSN), 1.5%; and Engineered Support Systems (EASI), 1.5%.
Because of the large number of stocks in the fund, the top 10 list can change drastically day to day purely on performance. As a risk-control measure, we don't allow any individual holding to occupy more than 3% or 4% of the portfolio's total assets.
Q: Tell me about OmniVision and FTI Consulting, both of which have performed extraordinarily well this year.
A: OmniVision designs, develops, and markets high-performance semiconductor imaging devices for various applications, including computing, communications, industrial, automotive, and consumer electronics. Digital telephones that have cameras in them have a great demand for this company's camera chip. OmniVision has seen its earnings grow 100% annually, but it still only trades at a p-e of about 31.
FTI Consulting, which is in the business of helping distressed companies by providing litigation and claims-management consulting, is a long-time holding. In this type of economy, we're seeing great demand for their services. We initially bought the stock in early 2001 at an average price of about $10 per share. We expect them to deliver annual earnings growth of 50% to 70%, and the p-e is only at about 18. Even if that earnings projection is too high -- let's say their profits grow 25% to 30% -- it's still a great holding.
Q: How large is the fund? Are you near a level that would cause you to close it?
A: We just reached $400 million. We closed the fund last May when it reached that figure. At the moment, we're planning on opening a new small-cap fund, probably in May or June. At such time, we will likely close the micro-cap fund, assuming it remains at the $400 million level or higher. Many of the best-performing stocks in the portfolio will probably be transferred to the new small-cap fund.
Q: What are your primary reasons for selling?
A: We start trimming back a position as a stock's market cap gets too big -- $1 billion in size. However, since we like to hold onto our winners, we'll maintain our position unless it reaches $1.7 billion, at which point we'll sell out entirely. We don't want to compromise the micro-cap nature of our fund.
In terms of performance and fundamentals, we sell when a company posts worse-than-expected earnings. When a stock has fallen 15% from its recent high or from our initial purchase price, we will automatically put it under review. However, if the overall market has slipped by say 20%, we'll hold onto it. A stock has to lose its "relative strength" to the market for us to dispose of it.
Q: As I recall, you had a rather high turnover rate. Has your turnover rate been increasing in recent years because of market weakness and volatility?
A: It hasn't increased. Our turnover was about 150% last year. In comparison, we had a turnover rate of 240% in calendar 2000.
Q: Since there are no widely accepted micro-cap stock indexes, you compare your fund to the Russell 2000 Growth Index. How does the fund compare to that benchmark?
A: As of Dec. 31, the fund had a median market cap of $221 million, vs. $380 million for the Russell 2000 Growth Index. We had a median forward p-e of 16.5, while it's 16 for the index. We also had a previous one-year EPS growth of 65.2%, compared with 13.9% for the benchmark.
Q: What's your outlook for the U.S. markets as a whole and the micro-cap sector?
A: Once this war with Iraq is over, corporate managers will again start buying goods and services. Capital expenditures in technology, which have been very slow the past three years, should increase. The micro-cap sector should improve dramatically as a result.