The Govett Smaller Companies Fund is a lesson in how a fund manager can make a dramatic difference in the performance of a mutual fund.
Once this fund was at the top among America's hottest. That was five years ago, when Garrett Van Wagoner was building his legend as the wizard of small- and micro-cap fund management. Van Wagoner is still a legend, but when he took that prowess to his own company four years ago, the Govett fund floundered.
That is, until it brought in London-based Julian Cooke and his team last year. Cooke's first job was unloading two-thirds of the fund's portfolio and shifting some investments overseas.
"We did unload a lot," Cooke said. And the fund established what he calls a "Four-M's screen" for investment criteria--a company's market potential, good margins, money or cash generation, and outstanding management.
"We spend a lot of time meeting companies," Cooke said. "We look for someone with a track record, with an achievable strategy to manage growth. We want a company in a growing market or growing market share."
Cooke's London base may seem curious for a fund that targets U.S. investors and holds two-thirds of its investments in U.S. companies with small market values. Still, all of Van Wagoner's previous U.S.-based successors had pretty much made a hash of the fund.
"We began looking for long-term business trends, tried to find the good players in those trends and stay with them," Cooke said.
Since his arrival in last year's third quarter, Cooke has turned the fund around. Govett Smaller Companies so far this year has returned 31 percent, outpacing the Standard & Poor's 500-stock index, which is up about 11 percent. Last year, the fund lost 11.7 percent while the S&P rose 28.6 percent.
Indeed, before Cooke's team took over, the fund hadn't made money for its investors since 1995, when Van Wagoner racked up a 69 percent return.
A fund manager has many more small-cap companies to choose from than large-cap companies. So Cooke and his team have focused first on identifying the most promising sectors, then the most promising companies in those sectors.
Cooke likes telecommunications, especially wireless, emerging technologies such as new media and the Internet, advertising agencies, health care, and, outside the United States, the outsourcing business.
Comverse Technology Inc., a designer and maker of computer and telecommunications equipment for multimedia communications companies, is the fund's largest single holding. With a $7 billion market capitalization, it's no longer a small-cap stock, having doubled in price this year.
While Cooke concentrates his investments in U.S. small-company shares, he recognizes that the hottest small-cap market in the world this year has been Japan. The Jasdaq index of over-the-counter Japanese stocks has more than doubled since Jan. 1.
"We have done well out of Japan, there's no doubt," Cooke said. "We look at trends and performance around the world."
The fund's team of managers looks for buying opportunities regionally, with specialists focusing on the United States from their base in Baltimore, and on Europe, Britain and Japan from a base in London.
"This has really worked well," Cooke said. "Our colleagues in Baltimore are less experienced managing global funds. In London we have more expertise in managing a global small companies fund. We have weekly meetings focusing on portfolio performance and talk whenever necessary."
Cooke believes that "the hardest thing for a fund manager is to sell something," from which springs his greatest failures, especially in the U.S. retailing sector, which the Govett Smaller Companies fund has largely abandoned.
He singled out Office Depot Inc. as one of his biggest disappointments. The shares have fallen 49 percent this year.
Cooke is confident that "there's not much portfolio risk."
"The risk is of a technological revolution which is big and not expected," he said. "The risk in that case would not be for all the stocks but for some number of stocks."
With more than 60 stocks in the portfolio at any given time, the risk is cushioned for any single share.
On the other hand, some small- and mid-cap shares can show extraordinary volatility. Electronics for Imaging Inc., which designs desktop color printing and is the fund's fifth-largest holding, is little changed this year after gaining--and then losing--56 percent.
Small-cap stocks in recent years have outperformed larger-cap issues, especially in the United States. Now, "the valuation gap between small and large is too wide," Cooke said. This should reduce the risk for small-cap investors, just as mega-mergers that have stoked the large-cap rally "begin to run up against regulatory issues," he said.
Over the past 12 months, the fund has returned 60 percent. And while Van Wagoner's legacy was a 69 percent return for 1995, the losses in the following three years ranged from 10.6 percent to 11.7 percent, leaving the fund with a five-year return of 10.9 percent, less than half the return of the S&P 500 during that period.
The Govett Smaller Companies Fund is a no-load fund, charging no sales or redemption fees. Its expense ratio is 1.95 percent, compared with an expense ratio of 1.66 for the average small growth fund, according to Chicago-based research firm Morningstar Inc.