A Safe Harbor in Micro-Caps
In a year scarred by severe market volatility, Bjurman Micro Cap Growth Fund (BMCFX ) soared 45.6% in 2000 -- in startling contrast to its benchmark, the Russell 2000 Growth Index, which sank 22.4%.
How was portfolio manager Thomas Barry able to prosper in 2000? He significantly reduced exposure to tech stocks in early 2000 and moved into health care, financials, and energy. Right now, Barry believes micro-cap stocks are more immune to any global economic slowdown than their larger-cap counterparts. He also thinks a Bush presidency will clearly benefit health care stocks.
Barry screens about 1,900 micro-cap companies -- defined as those with a market cap of $30 million to $300 million -- and selects those stocks using primarily quantitative analysis. Those with the highest trailing and forward earnings growth rates, and which trade at a low p-e relative to those growth rates, become candidates for the fund. Bjurman Micro Cap Growth carries S&P's highest three-year overall rank of 5 stars.
Standard & Poor's FundAdvisor recently had a chance to speak with Barry about the fund's performance -- and the stocks and sectors he likes now. Edited excferpts from the conversation follow.
Q: How large is the fund now and how many stocks are in it? A:
Q: How large is the fund now and how many stocks are in it?
A:We have $148 million in assets comprising about 85 stocks.
Q: To what do you attribute your superior performance last year relative to your benchmark Russell 2000 Growth Index? A:
Q: To what do you attribute your superior performance last year relative to your benchmark Russell 2000 Growth Index?
A:In the beginning of 2000 we were heavily invested in technology stocks; our exposure there was nearly 70%. We captured some huge gains from these stocks up until March. Then we felt some of these tech stocks were overvalued -- their p-es were too high relative to underlying growth rates -- and we weren't comfortable with such a heavy allocation in one sector. So we trimmed our tech exposure down to about 40%. This was right before the big Nasdaq crash in March. We moved this money from technology to three sectors where we happened to find attractive valuations relative to underlying growth: financials, energy, and health care. Subsequently, as technology issues declined in price, we captured gains in the latter three sectors.
By the end of the year, our tech exposure was down to about 23% -- so we avoided much of the carnage in tech. By comparison, the Russell 2000 Growth Index has a 30%-plus allocation in tech.
Another factor contributing to our outperformance was the extraordinary earnings growth of micro-cap stocks. To illustrate, companies in our portfolio had an average earnings growth of 112% last year, and the average p-e ratio was only about 23. By contrast, these figures for the benchmark were 39% and 21, respectively.
Q: What are the fund's current industrial sector allocations? A:
Q: What are the fund's current industrial sector allocations?
A:We have 17% in health care, 10% in energy, 10% in financials, and 23% in technology.
Q: What are the top holdings in the portfolio? A:
Q: What are the top holdings in the portfolio?
A:As of Dec. 31, 2000: Carreker Corp (CANI), 2.4%; Ameripath Inc (PATH), 2.3%; Inverness Medical Technology (IMA), 2.3%; SurModics Inc (SRDX), 2.2%; Taro Pharmaceutical Ind (TARO), 2.1%; U.S. Physical Therapy (USPH), 2.1%; OceanFirst Financial (OCFC), 2.1%; TALX Corp (TALX), 2.0%; Boston Communications Grp (BCGI), 2.0%; and MapInfo Corp (MAPS), 2.0%.
Q: Inverness Medical Technology did phenomenally well last year -- their stock price was up tenfold. Tell me about them. A:
Q: Inverness Medical Technology did phenomenally well last year -- their stock price was up tenfold. Tell me about them.
A:Inverness is in a very high-growth area -- they make self-test diagnostic products for the diabetes, women's health, and infectious disease markets. We purchased this stock early last year during our major shift out of tech. Self-test products preclude the patient from having to go see the doctor every month; as such there is a very high demand for these products. Inverness has enjoyed strong earnings growth. Their p-e got rather high, about 94, and so we've trimmed back a bit. We generally don't want a stock to represent more than 3% of the fund's assets.
Q: Discuss one of your favorite stocks among the financials. A:
Q: Discuss one of your favorite stocks among the financials.
A:OceanFirst Financial is the holding company for OceanFirst Bank, a federally chartered stock savings bank. It provides single-family residential mortgage loans and invests in mortgage-backed securities. Since the housing market was quite strong last year, and rates were relatively low, there's been a huge demand for these mortgage loans. The company's p-e is about 14, which is low compared to their 40% earnings growth. OceanFirst is simply a sound, low p-e, decent growth stock. OceanFirst's stock hit a 52-week high of about $25 at the end of 2000.
I should add, however, that financial stocks typically don't stay in our fund for the long haul. This is because they just don't have the type of solid, long-term earnings growth that you'd get from, say, high-tech and health-care stocks. Similarly, energy stocks are also not likely to be long-term holdings in our fund -- I wouldn't be surprised if we had no oil service stocks in the portfolio a year from now. Energy is a cyclical business; we are currently taking advantage of high oil prices. But we'll be prepared to get out when things go sour.
Q: Was the election of George W. Bush a benefit to health care stocks? A:
Q: Was the election of George W. Bush a benefit to health care stocks?
A:Without a doubt. Had the Democrats won, they were threatening to impose price controls on prescription drugs. In fact, when Bill Clinton first got into office in 1992, we had something like a 30% allocation in health care in our various portfolios. Then after Hillary started crowing about price controls, the industry went into an uproar, and we cut out exposure to health care entirely. The whole sector remained weak for several years.
Q: In an interview we did in early 1999, you said you believed that high prices of Internet stocks were justified by their projected growth over the next five to 10 years. What do you think went wrong with that assessment? A:
Q: In an interview we did in early 1999, you said you believed that high prices of Internet stocks were justified by their projected growth over the next five to 10 years. What do you think went wrong with that assessment?
A:I made that statement before the Internets surged astronomically in late 1999, early 2000 -- by which point they had become wildly inflated due to investors' euphoria. I still think that a handful of "dot.com" firms will deliver huge earnings over the next five years or so, but many will go bankrupt. Our selection process excludes most Internet companies anyway, since they have no earnings at all. Our exposure to Internets was never more than 4% in the fund.
Q: Do you still have a high turnover rate? A:
Q: Do you still have a high turnover rate?
A:Yes, since we are screening such a large universe of companies it's often possible to find new stocks to substitute existing holdings. Our turnover in 2000 was further aggravated by our massive shift away from tech stocks. We sell when a company's p-e ratio races far ahead of its growth rate. This was the main reason we sold all those tech stocks in early 2000. We also sell when a stock price declines or remains flat in an `up' market. We may sometimes sell a company when it reports weaker-than-expected earnings. In addition, we dispose of a company once it reaches a market cap of $1.5 billion.
Q: How are micro-cap stocks affected by the worldwide economic slowdown? A:
Q: How are micro-cap stocks affected by the worldwide economic slowdown?
A:These companies' stock performance has been generally unaffected -- but their earnings and revenues are not totally immune, because micro-cap companies feed their products to larger corporations, which, of course, are greatly impacted by macroeconomic factors.
However, I should add that since micro-caps provide very important products and services to large companies, their earnings have not slowed as much as similar, larger-cap companies. In fact, micro-cap health care stocks are virtually immune to economic slowdowns. Energy micro-caps are more sensitive to the price of oil than to the health of the overall economy. Micro-cap financials have also done well because of declining interest rates.
Q: Considering the success of this fund, why are micro-cap stocks still largely ignored by Wall Street? A:
Q: Considering the success of this fund, why are micro-cap stocks still largely ignored by Wall Street?
A:Large institutional investors don't bother with micro-caps -- they're just too small for them to consider buying.
From Standard & Poor's FundAdvisor