Small Wonders

Funds so diminutive that newspapers don't list them are outperforming the big boys

Some of the best mutual funds aren't found in the obvious places. They don't grace the daily fund listings of major newspapers. They're not offered in most retirement plans. Their logos aren't emblazoned on coffee mugs or billboards. They don't create funds as marketing gimmicks--in fact, they barely have marketing budgets. They're tight-knit, often family-run partnerships that invest their wealth alongside their clients. And they often make their mark with stocks that Wall Street shuns.

Tiny companies such as Allied Research Corp. (ALR ), maker of electronic security products, or sportswear manufacturer Delta Apparel Inc. aren't the sort to be featured in megafunds, but they get top billing in the likes of the $46 million Aegis Value Fund. Launched without fanfare in 1998 by Arlington (Va.) investment managers Berno, Gambal & Barbee Inc., it is the firm's only fund. "It allowed us to show the world what we can do, even if we don't have that million-dollar marketing smile," says fund manager Scott L. Barbee. Named for the shield of Zeus, father of the gods in Greek mythology, the fund has delivered 20% annual gains over the past three years, handily beating not only its peer group by 8 percentage points but also the Standard & Poor's 500-stock index' 18% gain. A nifty return of 37% through Dec. 4--the result of investing in stocks that trade below their liquidation values--catapulted it into the top 10 of all funds. "A lot of managers focused on beating the indexes in the short term, even if it meant destroying their clients' accounts with high-priced stocks," says Barbee. "They've got very significant egg on their face, and they deserve it."

This is the year of the boutique manager. The industry's stars look a lot like Boston Partners Asset Management LP, whose Small Cap Value Fund is up 53% in the 12 months ended Dec. 4. Its second fund--the Boston Partners Long/Short Equity Fund, is up 35%. Both are just three years old. Other newcomers such as the CGM Trust Focus Fund and Ameristock Focused Value are up 40% and 53%, respectively, this year. But don't get the wrong idea: Pumping out a few years of scorching returns doesn't cut it. Plenty of fly-by-night entrepreneurs crashed and burned at the end of the roaring '90s. The successful managers are steady hands who've been in the business for years. They're Turner Investment Partners Inc. in Berwyn, Pa., or Salt Lake City's Wasatch Advisors Inc.--experienced managers of old money before they launched funds. "There has never been a better time to manage a small or midsize fund," says Christopher J. Acito, managing director for Barra Strategic Consulting Group.

Not so long ago, such funds were put on the endangered-species list by Goldman, Sachs & Co. In a 1995 report, The Coming Evolution of the Investment Management Industry, it figured that a mutual-fund family needed to manage at least $150 billion of assets to survive. Today, the venerable bank is singing a different tune. "These small, regional firms are usually very, very profitable, and they are not under any tremendous pressure to get bigger to survive. This is a business driven by performance," says Managing Director Donald J. Truesdale.

PICKY PEOPLE. Performance is what they deliver. Today, more than 1,350 independent firms manage about $100 million each, according to researcher Nelson Information, a unit of Thomson Financial. And they are the crème de la crème of stock-pickers--sought after not only by the well-heeled but increasingly by big-time institutional clients. Even the big mutual-fund families are scrambling to hire them. Large-cap specialist Marilyn Holt-Smith and her partner Kristin Yates of Madison (Wis.)-based Holt-Smith & Yates Advisors have been deluged with business. "It's been wild," says Holt-Smith. "We are being asked to make our pitch in three different parts of the country on the same day." An annualized 18.74% 10-year return makes it No. 4 in the field of large-cap growth managers, ahead of far larger competitors such as Janus, Invesco, and Dresdner RCM, according to Money Manager Review in San Francisco.

The independents are surging thanks to the Internet and a budding corps of financial planners called registered investment advisers (RIAs). The Internet fostered mutual-fund supermarkets--no-fee, Web-based shops such as Charles Schwab & Co.'s OneSource and TD Waterhouse Group Inc.'s FundSmart OneStop--that allowed investors to shop among thousands of funds without paying steep brokerage fees and gave small funds a chance over the years to reach a huge new audience. "The industry became more of a meritocracy," says Kurt Cerulli of Boston's Cerulli Associates Inc.

Now, as nest eggs shrink and anxieties about the markets swell, do-it-yourselfers are keener than ever on professional help. That's where the advisers come in. The Internet is their low-cost back office, objectivity their selling tool. Rather than collect commissions on each sale, they charge a percentage of investors' assets as an annual fee. They don't have to peddle any parent company's products: Their only incentive is to increase clients' net worth--and that boils down to buying low-cost funds with standout performance. They take the time to find small up-and-comers that can make an outsize contribution to returns. So important is their link to investors these days that Fidelity Investments, Montgomery Asset Management, and others are falling over themselves to woo RIAs with free seminars, software, and other perks.

"SMALL IS AN ASSET." Even so, some tip-top funds are still off the radar screen. Consider Mosaic Mutual Funds of Milwaukee. Schwab's Mutual Fund Select List won't list the diversified fund since it has less than $50 million in assets, nor will major newspapers, which have all raised their cutoff points this year. But a handful of loyalists know of the $30 million Mosaic Equity Investors Fund's enviable record: a 14% annualized return since its inception 23 years ago. Advisers can easily raise fund managers on the phone at Mosaic. "Small is an asset when it comes to communication," says Larry Tabak, vice-president of Madison Investment Advisors Inc., which manages Mosaic Funds. "Some planners may be influenced by the traditional schmoozing and lunches, but most want to work with a firm that doesn't have so many layers of bureaucracy."

Such small funds are economically viable thanks to information technology and the ease of outsourcing administrative tasks such as shareholder communications and quarterly statements. A decade ago, it cost upwards of $100,000 to launch a mutual fund; today, it can run as little as $10,000. Now, a fund with only $4 million to $8 million in assets can be profitable, vs. about $75 million in the mid-1990s, says Kenneth D. Trumpfheller, president of Unified Fund Services of Indianapolis, an administrator for 31 independent fund groups. "All these folks have to do is raise and manage the money, which is what they want to do anyway," he says.

DIFFERENT DRUMMERS. The boutiques with the best returns specialize in investment niches. "We're purists," says Mellody Hobson, president of Chicago's Ariel Capital Management Inc., which favors value investing. In large part, it markets to African American investors. Seattle's Progressive Investment Management Corp. buys companies that are socially and environmentally conscious, a segment that's grown assets at 36% since 1999, far ahead of the industry's overall growth. The $5 million Corbin Small-Cap Value Fund, up 48% this year, buys tiny, fast-growing companies such as Forgent and Titan Corp. "We don't have to own the third-best car company or Microsoft," says David A. Corbin, who launched his only mutual fund four years ago as a sideline to his money-management business. The fund is ranked No. 5 among all equity funds this years.

What Corbin and his peers have in common may be the real clincher of success in investment management--entrepreneurial spirit. William G. Lowery of Chicago's Performance Analytics Inc., a consultant for $10 billion in pension and endowment assets, picks managers with "heart and conviction about their work, especially at the early stages of their success." His discoveries include Holt-Smith & Yates and Wood Asset Management in Sarasota, Fla. In 1991, he gave Richard H. Driehaus of Driehaus Capital Management Inc. four of his five first clients. Driehaus, an international stock manager in Chicago, today manages $3 billion. "You need a new name who's very hungry," says Lowry. "Otherwise you set yourself up for mediocrity."

By Mara Der Hovanesian in New York

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