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Get Four
|  | FEBRUARY 1, 2005
Playing It Safe in Small-Caps Gartmore Small Cap Growth Fund's Gil Knight sees the sector's solid gains winding down, although not for select eatery, health, and gaming stocks If you're into small-cap stocks, this is a time to be conservative, advises H. Giles (Gil) Knight, portfolio manager of the Gartmore Small Cap Growth Fund. The market as a whole is in a correction, he says, and small caps are underperforming. Knight points out that small caps have done better than large for six years in a row, and the cycle may well be coming to an end. Even so, in practicing his "growth momentum" style of management, Knight still finds small-cap stocks to like. One sector he sees as interesting is gaming, with more states allowing it, and among that group he points to Penn National Gaming (PENN ) and Station Casinos (STN ). Despite his concerns, Knight expects "significant gains" for small caps this year, although nothing like the 18% of 2004. And for the market as a whole, he sees around a 7% gain in the Standard & Poor's 500-stock index, up to about 1300. These were a few of the points Knight made in an investing chat presented Jan. 27 by BusinessWeek Online on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. AOL subscribers can find a full transcript at keyword: BW Talk. Q: Let's look at the broad market first, Gil. How do you see the prospects for 2005? A: We think the market, although it started off a little slow, is going to end up somewhere around 1300 on the S&P 500, around a 7% gain. Certainly it's going to back and fill for a few months here in the beginning of the year. Certainly people now are going to take some profits -- we've had quite a run recently. The economy's in decent shape, consumer spending is good, housing is good, we don't see a lot of inflation. The system seems to be saying all systems go. We're looking at a 3.7% GDP growth this year, which for a country the size of the U.S. is really quite good. So in spite of some of the worries out there right now, including the budget deficit and interest rates, we're fairly confident. Rising interest rates will likely not go high enough to affect the economy significantly, so overall we have quite a positive outlook on the market as a whole. Q: Brief description of your style and overall strategy? A: The style is what we call a "growth-momentum" style. It has been difficult this year, because growth momentum has been out of style. Value has beaten growth hands-down this year. Large-cap value was up about 15% last year, whereas growth was up about 6%. I think that, going ahead, we're looking for some better times for growth. If the economy starts to slow a bit, which it will, we're looking at an S&P 500 gain in profits that's lower than last year. If profits slow, people will look for more growth companies, and we like companies without a lot of debt (12% to 15% as a percentage of balance sheet). Companies with management that has the ability to execute are important as well. At least in the small-cap market, we'll probably see some significant gains, though not the 18% of last year. Q: So do you see small caps (and mid caps as well) continuing to outperform their larger brethren? A: Well, again at this stage in the business cycle, we would expect larger caps to outperform. I said this last year, and I was dead wrong. Small caps did quite well. But this year, we're not so sure. Small caps have outperformed large caps the last six years in a row, and small-cap outperformance tends to be cyclical, around five- or six-year cycles, and we're on the long end of that cycle. So I really don't think small caps will necessarily outperform this year. That doesn't mean we won't find small companies that will do well. Q: How long has the Gartmore Small Cap Growth Fund been in existence, and how has it been doing? A: I started that fund in December, 2003, so it has only been in existence a year. We lagged the market -- the fund was up around 9% this year, the index up around 12%. The reason was that in technology we focused a little heavily, which ended up being the worst-performing part of the sector. This sort of underperformance will happen, and it's not going to be out and away every year. I've been managing small-cap funds for probably 18 years. Q: Minimum and maximum capitalization for the fund? A: Minimum is $200 million, maximum is $2 billion. That's how we define small caps. Q: What have been some of your strongest small caps? A: We've done pretty well this year with a variety of stocks. Some of the best-performing groups so far have been the gaming stocks. As you know, there's a push among many states to allow gaming, particularly slot machines.... We have one, Penn National Gaming (PENN ), that has done very well. There's another one, Station Casinos (STN ), that we like a great deal. These are small-cap companies. We have a couple of retail stocks as well -- American Eagle Outfitters (AEOS ), who do specialty clothing, with 750 stores in the U.S. and Canada. We bought a little bit of Saks (SKS ). As we mentioned before, information technology did very poorly last year, with this being a major reason growth managers did not do very well last year. Cooper Companies (COO ) makes eyeglasses, contacts, and various solutions and has done very well. We have a few HMOs, which is an area which we believe will do very well. With Bush's emphasis on personal responsibility for health care, these should be on the rise. Molina Healthcare (MOH ) is a solid one, as is Sierra Health Care (SIE ). Another area we like has to do with mining. The price of coal has gone up, as have oil and natural gas. To mine, though, you need equipment. Joy Global (JOYG ) and Bucyrus International (BUCY ) are some of our strongest performers in the equipment industry. We will be buying more energy as well, and should become overweighted in them. Oil prices should be dropping back to $40 to $35 a barrel. At that price, most of the drillers can make a good return on investment. We can be involved with a number of these drillers -- Southwestern Energy (SWN ), UItra Petroleum (UPL ), along with a recent acquisition, Universal Compression (UCO ), which makes equipment used to compress natural gas and move it down the pipeline. We're underweighted in technology.... Plexus (PLXS ) is a recent buy of ours that has done well -- many of the companies we own are semiconductor and storage equipment testing. PLXS has around a 15% growth rate. Mattson Technology (MTSN ) is another we own. Ultratech (UTEK ) is a semiconductor-equipment manufacturer we've purchased, and Silicon Image (SIMG ) is a good outperformer we've acquired as well. In another sector, Florida Rock Industries (FRK ), which makes aggregates, is doing extremely well in the post-hurricane areas of the state. We own a couple of telecom-service companies -- Crown Castle International (CCI ) and Anteon International (ANT ) come to mind. Companies like Verizon (VZ ) and Sprint (FON ) have to pay rent to companies like CCI and ANT, which are tower producers and owners. With the scarcity of new towers, current prices are at a premium. In financials, we own Colonial BancGroup (CNB ), which is pretty well spread out in the South. It's growing around 9% a year in earnings. We have a REIT called Arbor Realty (ABR ), a real estate partnership in an industry that's paying very good dividends. A couple of other areas: We like Texas Roadhouse (TXRH ), a restaurant chain. We're going to expand into the area a bit -- people obviously have the funds to go out to dinner right now, even though food prices are going up.
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