Markets & Finance

Seizing on "Special Situations"


The Delafield Fund (DEFIX) has soared this year, partially due to takeovers, but also due to strong price appreciation from stocks beaten down in 2000. Co-managed by Dennis Delafield and Vincent Sellecchia, the fund was up 22.3% year-to-date through June 6, while its nearest benchmark, the Russell 2000 Index was up just 6.7%. The fund has also performed well against its mid-cap value peers since merging with the much smaller Reich & Tang Equity Fund last June. In the year through May 31, 2001, Delafield Fund rose 31.7%, while its mid-cap peers were up 21.1%.

The managers employ a strictly bottom-up investment style to select small and mid-cap stocks that appear to be significantly undervalued relative to cash flow, earnings growth, or strength of business franchise. They invest without regard to market-cap size, but do have a bias toward the small and mid-cap sectors.

The fund's portfolio currently has $123 million in net assets, comprising 49 stocks. Its five biggest holdings are MSC Industrial Direct (MSM), Trenwick Group (New) (TWK), Kennametal, Inc. (KMT), Englehard Corp. (EC), and Bell & Howell (BHW).

Palash R. Ghosh of Standard & Poor's FundAdvisor recently spoke with Selecchia about the fund's investing strategy, favored stocks, and recent portfolio moves. Edited excerpts of their conversation follow.

Q: How large is the fund currently?

A: We have about $123-million in net assets comprising 49 stocks.

Q: S&P classifies your fund as mid-cap value. Is this accurate?

A: While the market considers us a "small and mid-cap value" fund, we regard ourselves as a "value portfolio" with a small and mid-cap bias. However, we will invest without regard to market cap size if we can find attractive values. Our thrust is in the small and mid-cap sector because we feel this is where we can add the most research relevance. Presently, our average market-cap is about $1 billion, while our median market-cap is something like $850-million.

Q: What kind of stocks do you look for in this fund?

A: We invest primarily in stocks which we believe are undervalued and which represent "special situations." A special situation could be anything from a management change or the divestiture of a business or simply the fact that we think the company's shares are unduly inexpensive based on its cash flow or earnings. Our investment method is strictly bottom-up, and we tend to be very price conscious.

Although we don't like to compare our fund to any index, the benchmark that we are most often aligned with is the Russell 2000 Index.

Q: Relative to that index, how do your valuation parameters compare?

A: Relative to our fund, we think valuation units like average p-e are rather misleading or even meaningless because, for example, sometimes we might buy a company with nearly zero earnings -- but which we think has a great outlook. This kind of stock, with an infinite multiple, would greatly distort our portfolio's multiple valuation.

Q: What are your largest individual holdings currently?

A: As of June 5, 2001: MSC Industrial Direct, 4.9%; Trenwick Group, 4.0%; Kennametal, 3.7%; Englehard, 3.3%; Bell & Howell, 3.1%.

Q: Can you review one of your largest holdings and discuss how it illustrates your investment philosophy?

A: One of our larger holdings is Deluxe Corp. (DLX), a check-printing company, which has risen in price about 50% year-to-date. Deluxe has a wonderful cash-generating franchise in a maturing business. When we initially acquired them, we found the company to be attractively valued. Moreover, they had two distinct businesses (one of which was an electronic printing entity), and we determined that somewhere down the road they might realize full value from these pieces by separating them. This is precisely what happened earlier this year when they spun-off a company called eFunds Corp. (EFDS). When the spin-off was announced, the market yawned and Deluxe's stock price actually went down.

Q: Tell me about MSC Industrial, your largest position. That stock has been rather flat this year.

A: MSC is an industrial distributor that we had kept our eye on for years, but it was too richly priced for us. Then in May 1999, the stock dropped sharply and we bought a large position in it. The stock has been relatively flat so far this year because of the overall weakness of the U.S. economy -- MSC serves durable goods manufacturers. MSC's earnings have been flat-to-down all year, but it's a wonderful company with a strong balance sheet and is gaining market share. We're holding onto it because we think that when the economy picks up again, they'll be well positioned to flourish.

Q: Tell me about Trenwick, which has also been flat this year.

A: Trenwick is a cheaply valued re-insurance company. We think its earnings will improve relative to its peers, and it remains one of our larger holdings.

Q: What is your biggest sector?

A: Our largest sector is industrials. This makes sense because these types of companies tend to have many moving parts, and they are oftentimes going through transitions.

Q: Relative to the Russell 2000 Index, you have significantly outperformed this year. To what do you attribute this?

A: Our fund has performed quite well this year because the market has more fairly valued many of our holdings, which were beaten-down last year. Moreover, a number of our holdings have been taken over, like Shaw Industries, the carpetmaker, and Sunglass Hut.

Q: How much do you have in tech?

A: Tech is not a large sector in the fund, although in the last several months we've bought a few beaten-down tech stocks.

Q: What are your sell criteria?

A: We generally sell a stock when it reaches a fair value, relative to its earnings outlook; when the company fails to execute, or when fundamentals start to deteriorate. However, we don't adhere to hard and fast rules -- selling is much more difficult than buying equities. When a valuation gets a bit too lofty, sometimes we may simply scale it back, rather than sell it outright if its outlook still looks strong. Our turnover rate is somewhat high because of all the trimming and adding we do -- this is part and parcel of being a value manager.

Q: Can you cite a stock your recently sold outright?

A: We sold off Efunds, which was spun-off from Deluxe. It performed extremely well, then got too rich for us.

Q: What is your cash position?

A: In the kind of markets we've had, we like to keep cash as a hedge against volatility -- currently we have a 12% cash stake. It's more difficult now to find many undervalued names. From Standard & Poor's FundAdvisor


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