In an era that rewards outsize personalities and grandiose dreams — “Go big or go home,” as the saying goes — staying small seldom brings kudos.
But for the managers of three of the top-performing mutual funds of the fourth quarter, investing in the market’s mice — small-capitalization stocks — gave enormous gains. The trio define their mandates differently, but all often favor smaller fare.
Scott L. Barbee, portfolio manager of the Aegis Value Fund, calls himself a deep value investor: He typically sleuths for shares in sectors other investors have fled. “We’re trying to catch cyclical stocks at the trough or companies that are undergoing some kind of stress that’s created a lot of negative bias in the media and among other investors,” he said.
Mr. Barbee wants to buy stocks at steep discounts to his estimates of their worth. In particular, he assesses how a company’s book value — the net accounting value of its assets — compares to market values. The assets can serve as a floor for a stock price, because, in theory, a company shouldn’t be worth less than the net value of its assets.
Several years ago, Mr. Barbee’s digging led him to gold. “The gold miners, from 2011 and 2015, they were down something like 90 percent,” he said. “If you think about the broader market, in the Great Depression, it fell something like 90 percent. So you had this extraordinary collapse in valuation as the price of gold dropped.” When the metal price rebounded over the last couple of years, so did the stocks.
A willingness to wager on the unloved also prompted his investment in Resolute Forest Products, a lumber, paper and pulp company based in Montreal. “There’d been a tremendous investor focus on declining newsprint sales,” he said. “The advent of the internet and digital delivery has changed the news business, and this was causing huge declines in newsprint demand.”
Resolute is the world’s biggest producer of newsprint. But, having emerged several years ago from a bankruptcy, it had restructured, emphasizing tissue making and lumber production. As a result, Mr. Barbee said, “People are now seeing this as a lumber company instead of a declining newsprint business.” That translated into a fourth-quarter surge, when the stock rose more than 100 percent.
That jump contributed to an overall fourth-quarter gain for Aegis Value of 21.66 percent, compared to 6.64 percent for the Standard & Poor’s 500-stock index. The fund, whose retail shares have a net expense ratio of 1.75 percent, will celebrate its 20th anniversary this year. Over its life, it has returned an annualized average of more than 10 percent.
Resolute also helped propel the fourth-quarter gains of the Chou Opportunity Fund. Like Mr. Barbee, the fund’s manager, Francis S. M. Chou, is value investor. He said he aims to buy a stock for no more than $60 a share if he estimates its value at $100. “That’s my margin of safety.”
Resolute, for example, “was really cheap,” he said. “The book value was about $20 a share, and I bought at about $4. Even if you took the value of the newsprint away, it was still worth more than $4.”
Mr. Chou’s United States funds are relatively new — Opportunity began in 2010, as did his United States bond fund — but he has managed money in Canada for more than 30 years. His biography is unusual. He didn’t attend business school or toil at another investment company. Rather, he was a telephone-company technician, enamored of the stock market, and persuaded several friends to start an investment club. The club evolved into his first Canadian mutual fund.
He likens his investing style to bargain hunting at the store. “When you go shopping, you try to buy at a discount,” he said. “I do the same thing. I just need to understand accounting to evaluate the companies.” He’ll hold off buying unless he sees what he considers a great deal. “You have to have patience and buy when stocks are selling off for some negative temporary reason — like Resolute. Its valuation seemed as if it was totally dependent on newsprint.”
Morningstar, the investment information company, classifies Mr. Chou’s fund as a small-cap value offering, based on its holdings. But the fund can invest more broadly. Lately, for example, it has held large quantities of bonds and cash — the cash accounted for about one-fifth of its assets at September’s end.
“If you’re really picky, you may not be able to buy anything for a while,” he said. “If I can’t find anything I like, I’ll stay in cash.”
Mr. Chou’s fund returned 16.94 percent in the fourth quarter. It has a net expense ratio of 1.2 percent. For the last several years, Mr. Chou has not taken a management fee because he said he has been unsatisfied with the fund’s performance — the fund lost money in 2015 and 2016. He said he plans to begin taking the fee again.
Unlike Mr. Barbee and Mr. Chou, Alex Ely, portfolio manager of the Delaware Smid Cap Growth Fund, doesn’t obsess over cheapness. Rather, he seeks companies that can increase their earnings at well-above-average rates. “We’re fanatic growth investors,” he said. (Smid is a neologism for “small and mid cap,” though Morningstar groups the fund with small-cap growth offerings.)
To find potential investments, he first identifies big economic themes — two recent favorites are “money in motion” and “high-quality construction” — and then buys stocks that stand to benefit.
“Money in motion” means online banking, especially enabled by smartphones. While banks have offered online services for several years, Mr. Ely said consumer acceptance has advanced as the services have become easier to use. “I don’t think my son has ever been to a bank,” he said. “And soon we’re all going to do our banking online.” That’s why his fund holds both Epam Systems, a tech company whose offerings include financial-services software and LendingTree, an online lender and financial marketplace.
“High-quality construction” is Mr. Ely’s shorthand for where he sees growth in home building. Residential construction has been sluggish since the financial crisis, but the market is providing pockets of promise, he said. People continue migrating to places with “lower taxes and better weather,” like Tampa, Fla., Charleston, S.C., and Austin, Texas. So home building there is picking up, as are the stocks of builders that operate in the region, like LGI Homes, a recent top holding of the fund. Even in parts of the country where new construction remains slow, like the Northeast, people are increasingly renovating homes, he said.
By investing in American Woodmark, a cabinet manufacturer, Mr. Ely said, he aims to exploit both trends. New houses need cabinetry, and cabinet-heavy kitchens and bathrooms are “the leading areas people look to for improvements to their homes,” he said.
The Delaware fund, whose A shares carry an expense ratio of 1.21 percent, returned 18 percent in the fourth quarter.