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
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 (
) 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
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
) 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.