Looking Forward

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It's natural, but not necessarily profitable, to seek safety in numbers. A herd mentality explains the influx of investment dollars to bond funds. But a weak summer for equities offers an opportunity to build exposure to what should be the top-performing asset class once markets turn.

Small-cap stocks have posed a bit of a conundrum for investors. The group outperformed large-cap names in 2008, when large financials weighed on the S&P 500, and underperformed in 2009, a strong year for equities. Thus far in 2010 small-cap funds have outperformed their large-cap peers in terms of absolute total returns, but recent fund-flow data suggests that risk-averse investors hold the asset class in low esteem.

This sentiment isn't unjustified. Financial and health care reform continues to vex investors, while unemployment remains stubbornly high. And corporate earnings will soon face tougher year-over- year comparisons. Add in occasionally weak economic data at home and abroad, and you have a towering wall of worry for the markets to climb.

Despite the prevailing gloom, Sam Dedio, manager of Artio US Smallcap (JSCAX), is optimistic. "I think the fourth quarter will be better than the third," Dedio opines, and "I expect the stock market to be higher at the end of the year."

He also asserts that now is the time to beef up exposure to small-cap names. "Small caps tend to outperform for a couple of years coming out of a recession," Dedio notes. "And I don't see any reason why this time should be any different. I would advise investors to take advantage of the current weakness to position their portfolios for success when the market turns."

According to Dedio, you could be well compensated for your foresight. "If you go back to 1926, there's an almost 200 basis-point differential in average annual returns; small caps returned almost 11 percent on average, and large caps returned about 9 percent over the last 84 years."

Artio US Smallcap is an excellent way to capitalize on this differential. Over the past three years, the fund's returns rank it in the top 6 percent of Morningstar's Small Growth category.

This outperformance stems from a portfolio of 40 to 70 names that balances growth and value names. As Dedio notes, "We try to include bona fide growth companies in our portfolio as well as turnaround plays where we see a catalyst that will propel the stock to a higher valuation."

This approach has attracted Dedio and his team to industrials and financials; the fund is overweight the two sectors by almost 5 percent relative to its peers. The manager has also added select names in the consumer-discretionary and technology sectors.

Dedio highlights small-cap electronics retailer hhgregg ( HGG ) as the kind of growth story that the fund targets. "It's probably one of the best unit-growth stories in the small-cap retailing group today," Dedio enthuses, "And we think they can triple their store base over the next five years and do it profitably."

Founded in 1955, hhgregg boasts a strong presence inMidwest and has grown into a chain that includes over 150 stores in 15 states. The retailer snapped up storefronts vacated by bankruptCircuitCity at attractive leasing terms, and management plans to expand its store count more than 20 percent this year. These moves set the table for hhgregg to consolidate its No. 2 position behind Best Buy ( BBY ).

Thus far, the strategy appears to be paying off. The retailer is gaining share in its new markets, and favorable leasing terms have boosted margins. The company has also benefited from its move to a commission-based sales force.

On the other side of the portfolio, Integrated Device Technology ( IDTI ) is the quintessential value play. A small-cap semiconductor outfit, the company continues to transform itself from a vertically integrated chipmaker to a design-oriented firm that outsources production. Although the stock currently trades at $5, the firm's earnings power has convinced Dedio that "it could be a $10 to $12 stock if the positive trends continue."

Small-cap names tend to be more economically sensitive than larger-cap fare, but selectivity and a nose for value can limit the damage from cyclical volatility. And once equities find their legs, expect Artio US Smallcap to run with the bulls.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.

Article Republished with permission from <a href="http://www.KCIinvesting.com" rel="nofollow">www.KCIinvesting.com</a> and <a href="http://www.rukeyser.com" rel="nofollow">www.rukeyser.com</a>


This article appears in: Investing , Stocks

Referenced Stocks: BBY , HGG , IDTI

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