Owner-managers bring passion to fund
investing. After all, that's where their cash is
In some respects mutual funds are like restaurants.
If you want a really good meal, you stay away from the big chains and seek out
that tiny bistro whose owner is also the chef. Owners bring a high degree of
passion to the job because there is so much on the line. "A manager who is also
the fund company's owner wants to make money for shareholders because his
reputation and his enterprise are at stake," says John Deysher, owner of
Bertolet Capital and manager of Bertolet's Pinnacle Value Fund. "Failure can
mean bankruptcy."
Any advantage that small owner-managed fund groups may
have over corporate behemoths has not been statistically proven. But the record
is full of examples of boutique funds whose performance far exceeds that of
their peers. Eleven of the 20 top-performing diversified domestic equity funds
over the past 10 years are managed by their founders. That's a large number if
you consider that the vast majority of funds are run by big fund
complexes.
Most of these top funds are no longer undiscovered. Luminaries
such as Bridgeway Ultra-Small Company Fund and
Calamos Growth Fund are
either closed to new investors or are so large that they're not the nimble
players they once were. One thing that has been statistically proven is that
size matters. "Asset size plays an important role in performance," says Jim
Peterson, who heads mutual-fund research at Schwab Center for Investment
Research in San Francisco. "Funds that get too large have trouble putting money
to work." Some of the yet undiscovered gems of fund-dom, such as Auxier Focus
Fund (AUXFX ) and Runkel
Value Fund, are still small enough to be agile.
It's not a coincidence
that Auxier and Runkel are also the managers' names. "Think of the confidence --
the pride -- it takes to name a fund after yourself," says Barry Glassman, an
investment adviser at Cassaday & Co. in McLean, Va. "If the person's name is
on the door, he's going to be around for a long time." According to a study
Glassman conducted in 2003 of the 500 largest equity funds, 15 of the 16 named
after their managers were still run by their founding manager, and the 16th,
Davis New York Venture (NYVTX ), was run by the
founder's son, Chris Davis. What's more, 14 of those funds had beaten the
Standard & Poor's 500-stock index over the past five years -- 11 of them
over the past 10.
These boutique funds tend to be more flexible in their
investments, searching for absolute, not relative, return. They're not satisfied
to be down 10% even if their benchmark is down 12%. What's also important is
that these managers have most of their personal assets in the fund. Notes
Schwab's Peterson: "It powerfully aligns their objectives with
shareholders'."
SMALL IS
BEAUTIFUL There are some disadvantages to such tiny funds. They
often lack the research capabilities of larger firms. And it can be difficult to
keep expense ratios down since assets are too few to cover costs (though some
funds in our table have low expenses). Worse, an owner-manager could take
advantage of his fund's investment flexibility to make some big bets that
eventually go bad.
Finding these little treasures takes some effort.
Often it's a matter of watching for funds that do well in various scoreboards.
If you go to their Web sites, you might learn that the managers had experience
at a larger company before setting off on their own. Prior to launching Pinnacle
Value Fund in 2003, manager Deysher spent 12 years as an analyst at Royce &
Associates, one of the oldest and largest fund companies specializing in
small-cap investing. Deysher has an edge on his ex-employer because Pinnacle
Value, also a small-cap value fund, has only $11.5 million in assets. So it's
easy for Deysher to buy tiny illiquid stocks, such as textile maker Quaker
Fabric (QFAB ), which has
a market cap of just $50 million and trades for one-third its book value. That's
much harder to do at a larger fund because it's impossible to buy enough of such
a small company's shares to make a difference in a large
portfolio.
TrendStar Small-Cap Fund (TRESX ) has a similar story.
Co-managers Tom Laming and James McBride both previously worked at
top-performing Buffalo Small Cap Fund (BUFSX ), Laming as
co-manager and chief equity strategist for a decade and McBride as lead analyst
for three years. With just $125 million in its coffers, TrendStar is able to
invest in the small companies that are now out of their former fund's reach. "We
have a similar strategy to Buffalo's," says McBride, "but that fund became so
huge it was unwieldy. We'll close this one to new investors at $400 million."
Buffalo Small Cap has $1.8 billion and is closed to new
investors.
Another reason for going with owner-run funds is continuity of
management. A talented manager at a large fund company may get promoted, poached
by another firm, or leave to start a hedge fund. That's less likely to happen
with an owner-run fund. "I will do this as long as my health remains good," says
Randall Eley, the manager of the $13.5 million Edgar Lomax Value Fund (LOMAX ), which Eley founded
in 1997, and named for his grandfather, who inspired him to become an investor.
Eley didn't work for a large fund company, but he does have a track record of
managing accounts for individual investors that dates back to 1990.
Eley
buys large-cap stocks selling at a discount to the average price-earnings ratio
of the S&P 500. In running his own fund, Eley says, he doesn't feel any
pressure to hew to a benchmark, as many managers at the bigger firms do. His
fund is concentrated, typically holding just 35 to 40 stocks, and he is not
afraid to load up on a particular sector if it's out of favor. Right now he has
about a quarter of the fund in financial services. Although Eley shows
flexibility in his stockpicking, he still focuses mainly on large-cap
stocks.
Several of the boutique funds take flexibility to another level.
"We have the ability to invest wherever the risk is low and the returns are
high," says Jeff Auxier, manager of the Auxier Focus Fund. Auxier's willingness
to invest in stocks and bonds of any stripe has produced powerful results. His
fund's 9.3% five-year annualized return ranks in the top 3% of all moderate
allocation funds, according to Morningstar. More important to Auxier, the fund
has had just one down year in its six-year history. That was 2002, when it lost
6.8% vs. the S&P 500's -22.1% return.
Manager Charles Smith of Fort
Pitt Capital Total Return (FPCGX ) also has a
go-anywhere style. To him the most important decision is not what stocks to be
in, but whether to be in stocks or bonds. "An investor's returns are far more
influenced by their asset-allocation decision than their stock selection," he
says. "We want to make that decision." This does not mean the fund winds up
being like the typical balanced fund, with a certain percentage always in stocks
or bonds. Right now, Smith has nothing in bonds because yields are too low, but
he will start moving into them if yields on long-term Treasuries hit 6.5%. At
double-digit yields, he would go to 100% bonds, something he did in the early
1980s when he managed individual accounts with Ron Muhlenkamp. He later
co-managed the Muhlenkamp Fund.
STEALING SMART
STRATEGIES More often than not, unique funds come from the
boutiques. Pennsylvania Avenue Event-Driven Fund specializes in merger
arbitrage, typically the domain of hedge funds. Only two other mutual funds
manage money this way, both also at boutique firms. One of them, Merger Fund (MERFX ), is closed to new
investors, and the other, Arbitrage Fund, has a higher expense ratio and worse
performance than Pennsylvania Avenue, according to Bloomberg Financial Markets.
Pennsylvania manager Thomas Kirchner attributes part of his fund's success to
its tiny $500,000 asset base. In 2004 the fund was up 26.8% while its
competitors treaded water. For sure, Kirchner needs the fund to get larger -- it
would take $5 million in assets to turn a profit. But that's not so large that
it would preclude investing in the smallest deals, which the larger players
don't consider.
Manager Jonathan Ferrell's Rock Canyon Top Flight Fund
(TOPFX ) also goes his
own way in cribbing from hedge fund strategies. He practices momentum investing,
which often means rapid trading. He also sells stocks short. Rock Canyon has a
3.03% expense ratio -- exorbitant for a mutual fund but reasonable for a hedge
fund.
If you find the right fund, there's a chance you could invest in it
for life. "I sometimes joke with my partners that I'm going to be here running
this fund when I'm 95 and covered with cobwebs," says Fort Pitt's Smith, who's
45. "I sometimes say, though not too loudly: 'I'd do this without being paid."'
That's the kind of passion for investing that fund shareholders should seek
out.
