Top Tier Mutual Fund Wins With Singles, Not Home Runs

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If Loomis Sayles Small Cap Growth Fund were a baseball team, it would be cruising into the playoffs near the top of its division.

And it would be doing so with a lineup that wins with singles and doubles rather than home runs.

The fund is up 39.71% this year through Sept. 30. That tops 92% of its small-cap growth peers, which averaged 30.35%. It also beat the S&P 500's 19.79%.

The $1.1 billion fund is closed to new investors. Co-managers John Slavik and Mark Burns, on board since 2005, talked with IBD about their approach from their offices in Boston.

IBD: Tell me about your strategy of relying on scoring runs with a steady string of hits rather than just a few four-baggers.

Burns: You're right in the sense that we are not making big bets. But I would say that we look for very dynamic growth companies that can be very strong stocks over time. They can be home runs.

We also understand that because they grow aggressively, if they take a misstep they can be hurt. So we control the volatility of individual names by controlling position sizes and with other tools. If one of our names goes off track, it does not torpedo the entire portfolio.

IBD: Is your approach because investors were burned within the past 15 years?

Slavik: We've seen two bear markets in a decade, when many clients and prospective clients had extremely bad experiences. So we're trying to mitigate volatility and risk with higher-quality stocks. Risk management is done at the stock level with position sizes and at the portfolio level with large guardrails around the portfolio.

IBD: What are some of those controls?

Burns: We have stocks whose balance sheets have less leverage than their benchmarks. These companies are protected by barriers to entry by competitors. They generate cash. And they have visibility into their revenue streams, which makes them less volatile.

The holy grail is for a company to go from small cap to midcap to large cap. Most won't achieve that. But we want companies with a legitimate shot at that.

IBD: Give me an example, please.

Burns: Lumber Liquidators ( LL ) has been a five-bagger for us.

We first bought it (in September 2011), early after they changed management. We liked their business model, returns on capital, margins of their stores. It became a bit of a housing play as well. But we didn't buy it for that. We bought it because it could take share within its category.

IBD: You got in early, when you saw a secular growth story. You've been trimming since it became a cyclical story, right?

Burns: Yes.

IBD: Why do you likeCommVault Systems ( CVLT ) in comparison to other database managers?

Slavik: We found that they had a data management solution that works in any storage environment. And compared to others, CommVault gives you a more granular view of data -- their software can process data in small chunks and allocate it more efficiently in the storage environment.

They give you an ability to move it, index it, protect it at a more granular level than some imbedded solutions in the market.

Customers get a good return on investment, sometimes to the tune of a 40% hard dollars savings vs. existing peers in the market.

And they're at the beginning of another major product cycle (for Simpana 10), which has the potential to expand the addressable market for them by almost 50%. And this is going to reach areas like mobile, machine-log data (a log of every action by every machine on a network) and analytics.

IBD: What do you mean by embedded solutions ?

Slavik: Embedded refers to large storage players,EMC ( EMC ) andNetApp ( NTAP ), that offer both the hardware and software component and tend to have less robust software offerings, which can't process data at the level of sophistication that CVLT can.

IBD: What distinguishesEpam ( EPAM ) from other software product development firms?

Slavik: We bought it in June. Many of their rivals are big-body shops -- they're labor intensive. Their services and therefore revenue scale with their head counts. Those are not overly exciting to us.

But Epam is growing its customer base rapidly, driving their top line. We think this is a 20% or so organic grower from a top-line perspective.

Also, they're in Eastern Europe and the CIS region (many states of the former Soviet Union), which has been underpenetrated in this space.

And it's reasonably valued.

IBD: What distinguishesGrand Canyon (LOPE) from other for-profit educators?

Burns: This is the only for-profit education name we own. It's a difficult space.

This is differentiated. They have a traditional campus in Phoenix, so students can have a regular college experience, live in a dormitory. They have a Division I basketball team. Those things have helped fuel the brand, which has enabled them to leverage their online brand.

They offer a high-quality education for a reasonable price. Those give visibility to differentiating their strategy.

IBD: You like names that stand out. Are low costs what differentiateSpirit Airlines (SAVE)?

Burns: Clearly they are an ultra-low-cost carrier. They have meaningfully lower airfares. They've opened geographies that are not well served by traditional carriers, which has enabled them to grow flights. And they have a clean balance sheet.

IBD: Noodles & Co. (NDLS) is new to the portfolio. Can their mix of Asian, American and Mediterranean cuisines work?

Burns: We bought this at the IPO (in June). We didn't get a meaningful allocation. The deal doubled on the first day to 36 from 18. We had a 36 price target, so we did not buy more. When it became clear in July it would not come back into our price range, we eliminated it. We did think the concept is scalable. We hope there will come a day when we can initiate a position again.

IBD: What distinguishesOasis Petroleum (OAS) from other small-cap exploration and production firms?

Slavik: They're very focused on the Williston Basin in North Dakota and parts of Montana. And they're exploiting the Bakken shale play (in the Dakotas and Canada). They were relatively early to the play. They're operating more rigs in the play. They are in the sweet spot of the play.

In addition to showing production growth of 50% this year, their well costs are coming down.

And they're getting more involved in pad drilling, where they drill more wells from the same acreage with horizontal wells. It's a more efficient way to get the resource above ground faster.

IBD: Prototyping does not sound sexy. ButProto Labs' (PRLB) share price nearly doubling this year does.

Slavik: They do CNC machining, which stands for computer numerical control. It involves milling machines controlled by computers, which are programmable, so you don't need a technician to control the mill that's cutting a block of aluminum and to protect the molding.

This company is disruptive. Their competitive advantage resides in their software. If you are an engineer for a large manufacturer, you can submit a CAD design for a part you need. This system will tell you whether your CAD design is sound, give you a quote based on the number of parts you need and a delivery date, which is measured in days instead of the weeks or months that you'd get from some mom-and-pop shops that they compete against.

They take share from legacy players. They're growing their top line north of 25%. And there continues to be a lot of runway for continuing their growth.

IBD: What enablesUltimate Software (ULTI) to compete with the much biggerADP (ADP)?

Burns: We bought this in January 2009, in the bear market, when the stock was in the midteens. It's up 10-fold since then.

They provide a payroll solution. They were a pioneer in the software-as-a-service market.

Their solution is more elegant and lower cost than perpetual licenses and installations on premises.

Their CEO has a sales background and built an aggressive sales culture around taking share from the 800-pound gorilla, ADP.

In addition to payroll, they have modules in recruiting, time management and other human capital areas, which increase the average dollar per employee that Ultimate can obtain from its customers.

Their penetration at existing customers and their revenue per employee could more than double. In their smaller midmarket customers, in theory revenue could go up by 50%.

IBD: What revs you up about new- and used-car dealerAsbury Automotive (ABG)?

Burns: When we bought the stock in 2010, U.S. car sales had bottomed and edged up to 10 million units. They've rebounded to 16 million as of August.

And it's almost become a razor-razor blades business. Almost half of the revenue growth is from service, not sales.

And as sales rebound, there are more cars in the 2- to 5-year-old range (when owners focus on maintenance). That allows service to be a tailwind for earnings.

IBD: Dorman Products (DORM) is a newcomer to the portfolio. Is it a play on economic recovery?

Burns: We bought it in February. They make aftermarket auto parts used by do-it-yourselfers and small mechanics. They're working on vehicles more than five years old. It's a very steady business. It grows in the low double digits. It's all about exclusive new parts. If you're first to market with, say, the latest catalytic converter, you garner the most news sales.

IBD: IsCoStar Group (CSGP) a play on a rally in commercial real estate?

Burns: You're right. They want to be the Bloomberg of commercial real estate data. Their data describes everything: number of square feet on each floor of a building, lease rates, rental rates and so on. It's sold to brokers and others.

They acquired LoopNet, the online commercial real estate marketplace and a smaller competitor, which provided them with a large customer base to cross-sell into.

IBD: You own about 100 names. Is that for risk management?

Slavik: This is a diversified growth product that relies on stock selection to drive excess returns. This is not a concentrated product that relies on a small number of bets. And we don't make bets based on the macro environment or the market. Those are too difficult to replicate repeatedly.

And, yes, this product focuses on risk management. When people hear that, they wonder if we are GARP (growth at a reasonable price) or core investors. No, we are growth managers.



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.



This article appears in: Investing , Mutual Funds

Referenced Stocks: CVLT , EMC , EPAM , LL , NTAP

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