Markets & Finance

A Tight Focus on Value


Golden Oak Small Cap Value Fund (GOSVX) looks for undervalued small-cap stocks with strong cash flow and very low debt levels. The investment team at the fund's investment advisor, Systematic Financial Management L.P., currently has a heavy emphasis on financials and consumer cyclicals. Year-to-date through June 25, the fund gained 14.7%, outpacing its benchmark, the Russell 2000 Value Index, which rose 8.6%.

For 2000, the fund rose 22.6%, keeping pace with the index, which gained 22.8%. The small-cap investment team at Systematic includes Gyanendra "Joe" Joshi and Kenny Burgess, who have managed the fund since inception in September 1999. The fund is still too new to have received a ranking from S&P.

The value orientation is evident in the portfolio's average price-to-earnings ratio (p-e) of about 14 (versus 17 for the benchmark). The fund's largest sector right now is consumer cyclicals. And in hewing to the small-cap focus, stocks are automatically sold when market cap reaches $3 billion.

Palash Ghosh of Standard & Poor's FundAdvisor recently spoke with Joshi about the fund's investing strategy, top holdings and recent portfolio moves. Edited excerpts from their conversation follow:

Q: How large is the fund in net assets and number of stocks?

A: We have about $71.3 million in net assets comprising 60 stocks.

Q: What are your buy criteria?

A: We are looking for undervalued stocks with strong cash flow, very low debt and improving earnings. Stocks in our portfolio have initial market caps of between $100 million and $2 billion. We like to maintain a small-cap bias in the fund -- the average market cap is about $1.2 billion. Our investment style is strictly bottom-up with our major emphasis on picking stocks with the best potential to rise in value over the next one to three years. The average p-e in the fund is about 14, while our benchmark, the Russell 2000 Value Index, has an average p-e of 17.

Q: What are your largest holdings?

A: Astoria Financial (ASFC), Banknorth Group (BKNG), AnnTaylor Stores (ANN), American Woodmark (AMWD), Washington Federal (WFSL), Webster Financial (WBST), Sovereign Bancorp (SVRN) and Datascope Corp. (DSCP). Currently, five of our 10 largest holdings are banks.

Q: Are financials your largest sector?

A: Our largest sector is consumer cyclicals, where we have a 24% weighting, compared with 19% for the benchmark. Financials represent our second largest sector, at 23%. However, relative to the benchmark, we are quite underweight there; the index has a 31% or 32% allocation in financials.

Q: Can you take some of your largest holdings and discuss how they fit your investment style?

A: Astoria Financial is the second largest thrift in Long Island, New York, with $22 billion in assets -- an unbelievable number. Despite its tremendous growth it still trades at a p-e of only 10 and has a yield of about 2.3%. There is substantial value here -- it's stock price is selling at 1.6-times book value, which on a historical basis is very attractive. Year-to-date, Astoria Financial's stock has steadily risen from about $50 to $57.

Banknorth -- a multi-bank and financial services holding company operating throughout New England and New York -- has a similar kind of valuation profile as Astoria Financial. Banknorth has a p-e of about 11 and year-to-date the stock has gained about 15%.

Although American Woodmark is not in an exciting business, its stock has performed spectacularly well this year. Year-to-date the stock is up 150%, but its p-e is still only about 13. This company makes and distributes kitchen cabinets and vanities -- they serve the new homebuilder and consumer remodeling markets. They dominate their market niche. We first acquired a position in the company back in 1999 when they were undergoing some problems and their margins were seriously hurt.

Q: What are your sell criteria?

A: We have an automatic sell when a company reaches a market cap size of $3 billion. For example, we'll soon be selling off Banknorth from this fund as its market cap has reached this level. We still like the company and will keep it in one of our mid-cap portfolios. We also sell when the stock becomes overvalued, based on a cash flow basis. We'll also sell when we identify some phenomena that we think will harm a company's cash flow. Our annual turnover rate is quite low -- about 40%.

Q: Do you think small-cap stocks will continue to outperform large-caps?

A: I think we have entered into a long-term cycle (at least four to six years) in which small-cap securities will outperform large-caps. And we are only about 18 months into this cycle, so we're quite optimistic about the small-cap sector.


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