April 10 (Bloomberg) -- Michael Cook, founder of the SouthernSun Small Cap Fund, was born and raised in Memphis, Tennessee, and he likes it there just fine.
When he decided to go into finance, Cook, now 55, joined as a broker at the local Merrill Lynch & Co. office. He moved into money management in the trust department of Memphis’s own, now-defunct Union Planters Bank. After getting a pink slip in 1989 when the bank sold its asset management unit, he could have sought work among the big fund firms in New York and Boston. Instead, he stayed in Memphis and started SouthernSun Asset Management LLC.
Cook’s out-of-the-way location has done nothing to hurt performance, Bloomberg Markets magazine reports in its May issue. His $300 million small-cap fund returned an annualized average of 41.1 percent per year for the three years ended on Feb. 17, helping him win the top spot in the U.S. small-cap category in Bloomberg Markets’ annual ranking of mutual funds. Average total return for the Standard & Poor’s 500 Index for the same period was 22.5 percent.
Cook’s fund, whose largest investments are in agriculture and construction equipment companies, was tied for third-best in a ranking of all U.S. diversified funds.
The ranking measures market performance in a time of huge volatility, with stocks and bonds crashing in 2008 and shooting up in 2009. Cook’s fund is an example; it gained just 9.7 percent on average over five years. The S&P 500 Index returned 0.8 percent annually in the same period.
The Bloomberg Markets stock and bond fund rankings include U.S.-domiciled funds with at least $250 million under management. Funds are ranked by total returns for one, three and five years and by their Sharpe ratios for three and five years. The Sharpe ratio measures the performance of a fund adjusted for risk.
Five of the top 10 funds in the diversified U.S. equities fund ranking manage small-cap or midcap stocks.
“Smaller companies tend to have more business risk, and they can be a little more volatile than large-cap funds,” says Katie Reichart, a senior fund analyst at Chicago-based research firm Morningstar Inc. “But small-cap value funds, in particular, have had some of the best long-term returns.”
SouthernSun is such a fund. The category had an annualized return of 32 percent during the three years through March 12, compared with 23 percent for large-cap value funds, according to Morningstar. Over five years, small value had a 2.6 percent return, outperforming large value by more than 2 percentage points.
Iben Changes Jobs
Global equity funds showed the same pattern as small caps, with high returns over three years and modest results over five. The good news for Chicago-based Nuveen Investments, a unit of Madison Dearborn Partners LLC, is that funds managed by David Iben continued to dominate the global equity category, taking three of the top four spots. In Bloomberg Markets’ 2011 ranking, funds managed by Iben were Nos. 1, 2 and 4.
The bad news for Nuveen is that Iben, head of the firm’s Tradewinds Global Investors subsidiary, will leave in June to join Boston-based hedge fund Vinik Asset Management LP, founded by former Fidelity Investments stock picker Jeffrey Vinik.
Nuveen spokeswoman Kathleen Cardoza says that Iben will be missed but that Tradewinds has a “deep team” of fund managers. He will be replaced by Emily Alejos and Andrew Thelen, Nuveen veterans who will serve as co-chief investment officers.
Prudential Fund No. 1
In global bonds, the $1.6 billion Prudential Total Return Bond Fund was No. 1 after returning 12.6 percent annually during the three years ended on Feb. 17. The fund, run by Newark, New Jersey-based Prudential Financial Inc.’s Prudential Investments LLC, competes with go-anywhere bond funds such as Bill Gross’s Pimco Total Return Fund and William Eigen’s JPMorgan Strategic Income Opportunities Fund.
Michael Collins, who’s the lead manager of the Prudential fund, attributes its strong risk-adjusted returns to his desire to keep the fund diversified.
“A lot of our competitors seem to have a bias toward being overweight in specific areas, an example being a big interest-rate bet or a global macro bet,” Collins says. “We’ll rotate aggressively across sectors, but we always ensure that we don’t have too many eggs in one basket.”
Collins says he knows bond returns will suffer when interest rates rise, yet he’s confident demographic trends will keep bond funds popular. As the U.S. baby boomer generation heads into retirement, more investors, he says, will be relying on the relative safety of debt.
2020 Fund Wins
The top U.S. bond fund is the $303 million American Century Investment Zero Coupon 2020 Fund, which took advantage of the spike in the value of intermediate and long-term U.S. Treasuries. The fund invests primarily in zero-coupon securities that mature in 2020, when the fund will liquidate. It returned 13.8 percent annualized during the past three years and 15 percent over five years.
The fund, managed by Robert Gahagan and James Platz, is one of a series of funds opened by Kansas City, Missouri-based American Century Investment Management Inc. in 1985 and whose bond purchases are set to five-year intervals.
Much of its holdings are in U.S. Treasury strips: bonds whose coupon payments have been packaged and sold separately, leaving only the maturity payment for the holder. They’re typically sold at a discount. The fund appeals to investors who know they’ll need a payout in or near 2020.
Gahagan, 53, says that investors aren’t likely to flee even if interest rates rise, which will drive down the price of bonds.
“The fund can be volatile, but, remember, many investors have locked in a predictable rate of return,” he says.
SouthernSun’s Cook is a plain-spoken Southerner who gave up his religion and philosophy studies at Covenant College in Lookout Mountain, Georgia, before going into finance. He relies on his love of research and of “good old-fashioned logic” to generate returns for his investors. He’s suspicious of what he sees as the tendency of many asset managers to overcomplicate the process.
“We have become mesmerized by what we think complex algorithmic notions can yield,” Cook says. “By digitizing things, we think we have all the necessary information to correct anything, and it’s just not true.”
Cook has always focused on small to midsize companies because they, too, keep things simple and are best at turning good management decisions into profits.
‘A Unique Niche’
“We make sure the business has a unique niche and has a process where they can move ideas to execution,” he says.
His favorite current investment is Agco Corp., a Duluth, Georgia, agriculture equipment maker.
Cook manages a total of $2.6 billion, most of it in separate accounts for institutional investors -- one of which is Memphis-based FedEx Corp. SouthernSun slowly built its client list from local families and businesses. Cook’s first client was his father, who, Cook says, still calls him twice a week “to tell me what I’m doing wrong.”
Cook began marketing his firm when he launched the mutual fund in 2003. Focused on companies with a market capitalization of $500 million to $2 billion, it’s his only retail fund. As its returns have climbed, so have its assets, swelling almost fourfold in the 15 months ended on Feb. 29. Cook runs an investment team of five people, including his 30-year-old son, Phillip.
While Cook stresses simplicity in value-oriented stock picking, he emphasizes that it’s also rigorous.
‘Limb From Limb’
“We pore over the financials, tear them limb from limb, visit the management,” he says. “I have to be able to understand who the critical decision makers are.”
After months of study, the fund typically takes a position no larger than 1 to 1.5 percent of its assets when it first invests in a company.
“I don’t think you ever really know a business until you own it,” he says. “Our philosophy is never to make huge mistakes.”
The fund’s largest holding as of Dec. 31 was Darling International Inc., a recycler of animal byproducts based in Irving, Texas, which returned an annualized 75 percent during the three years ended on March 12. The stock of another holding, Brentwood, Tennessee-based Tractor Supply Co., also rose an average of 75 percent over the period.
Cook says the firm will open its second mutual fund in the spring. It will follow an investment strategy -- initiated in 1996 for the firm’s institutional accounts -- that focuses on companies with a market cap of $1 billion to $8 billion.
“Our intent is just to keep plugging away,” Cook says. “Hopefully, we’ll make our clients money and not overly impress them with a process.”
To contact the reporter on this story: Christopher Condon in Boston at firstname.lastname@example.org.