| BUSINESSWEEK ONLINE : JUNE 28, 1999 ISSUE | ||||||||
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| BUSINESSWEEK INVESTOR
Macro Gains from Microcaps Robert Kern and his Fremont fund outpace the S&P With armies of Wall Street analysts, pundits, and investors scrutinizing the Dow Jones industrial average's every move, not much attention has been paid to the tiny stocks followed by fund managers such as Robert Kern. Does that bother him? No way. Kern says his Fremont U.S. Micro-Cap Fund thrives on investors' neglect of the 5,230 issues that occupy the bottom 5% of the stock market's value. For many beleaguered small-stock investors, that theory rings hollow. Funds that specialize in small-cap stocks are up a meager 3.4% so far this year, following a dismal 1998. Microcap funds have fared better, rising 11.1% this year and 10.7% over the past year, says fund tracker Morningstar. But the $200 million Fremont U.S. Micro-Cap has racked up a 27% year-to-date gain, outpacing the Standard & Poor's 500-stock index by 21 points and initiating a turnaround for the fund. After soaring 54% and 49% in its first two years, Fremont U.S. Micro-Cap trailed its benchmark--the Russell 2000 growth index--in 1997 and had a lackluster '98. Now, with a recovery under way, the fund is on track to celebrate its fifth anniversary on June 30 with a compounded average annual gain of 26.3% over the past five years. That just beats the S&P's annualized five-year return of 25.6%. Kern attributes his recent strong performance to deft maneuvering. As stocks sagged last summer amid Asia's financial crisis, Kern pared down the fund to its best holdings. He and his five-member team at Kern Capital Management--including his son David and Senior Vice-President Judy Finger--jettisoned 20 stocks, or one-quarter of the portfolio. When investor sentiment turned positive in the last three months of 1998, the fund zoomed 44%, more than recouping its 29% loss in the third quarter. In microcaps, stock-picking is key. Whereas many managers of large-stock funds chase their benchmark--the S&P 500--by replicating its most influential holdings, microcap managers have thousands of obscure companies to choose from. To help winnow the field, Kern's team screens for criteria including revenue growth rates of 20% or more, price-earnings ratios below 20, and plenty of cash to weather bad times. Still, that method can miss good prospects. Take OrCAD, a maker of software for electronics designers. Kern says that thanks to a new Web-based initiative, the company can increase revenues at a much faster rate than its recent 8.3%. ''We look at where innovation is occurring and ask if microcap companies will be major beneficiaries,'' Kern says. About 15% of Fremont's 67-stock portfolio consists of ''development stage'' companies--many with no earnings, such as circuit and switch manufacturer Ancor Communications. To value candidates, Kern plays mogul and asks himself whether he would ''buy the entire company at the market value of the equity.'' He also meets managers to assess their vision and discipline. Nowadays, many investors view ''startup'' as a code word for fledgling cybercompanies. But because of concerns about high stock valuations, Kern is avoiding Net-based businesses. Instead, he has invested about 10% of the fund's assets in companies, including hi/fn and Orckit Communications, whose products provide high-speed and secure access to the Internet. LOTS OF CASH. Perhaps because of Kern's 20 years of experience, he isn't afraid to place big bets in this volatile sector. The fund has about 30% of its assets in its top 10 picks (table). About 29% is in tech stocks. Because the fund recently attracted a wave of new investment, 20% is in cash. But Kern says he is looking to put at least half of that to work soon. Is there anything Kern would change about his fund? He would like to reduce its above-average expense ratio of 1.94%. To do so, he wants to spread costs over a wider investment base. That shouldn't be a problem--as long as the fund's performance continues to attract new cash. BY ANNE TERGESEN _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ BACK TO TOP |
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RELATED ITEMS Macro Gains from Microcaps TABLE: Kern's Top Holdings INTERACT E-Mail to Business Week Online | |||
