Where Driehaus Funds Hunt for Growth


By Amey Stone What are growth-fund managers to do in an investment climate like this, where growth is hard to come by and stock prices are more inclined to shrink than expand? Just how tough their job is, especially for the most aggressive managers, was all too apparent at an Oct. 1 press briefing by Chicago's Driehaus Capital Management, which manages five international mutual funds as well as more than $2 billion in accounts for institutions and wealthy individuals.

The outfit's strategy is to identify companies with robust sales and earnings growth. With skyrocketing returns in the late '90s, Driehaus developed a reputation for fast trading in hot sectors, especially in small-caps and foreign markets.

Lately, however, the ultra-aggressive stock-pickers don't have too many hot sectors to choose from. At the recent press briefing, portfolio managers' best ideas for this difficult environment amounted to niche plays in specific U.S. sectors and jabs into places like Korea and Russia. The firm was also rolling out a new strategy in a hedge fund restricted to high-net-worth investors: selling short.

HOLDING UP. "It's a difficult time, but we're finding selective groups that outperform," Richard Driehaus, the firm's CEO and lead portfolio manager, told the press. Indeed, although returns at Driehaus' funds are negative this year, four out of five still earn Morningstar's highest rating. They have held up better than many of their peers in 2002, and their long-term results still benefit from stunning growth in 1999.

For example, the five-star-rated Driehaus Asia Pacific Growth Fund (DRAPX), is down 6% this year. In 1999, it gained 264%. Driehaus International Discovery (DRIDX), another five-star fund, is down 14% this year but was up 214% in 1999. The only two-star-rated fund, Driehaus International Growth (DRIGX), is down 25% this year (in 1999 it gained 99%).

Sheldon Jacobs, editor of the No-Load Fund Investor newsletter, now recommends Driehaus European Opportunity (DREOX), which is down 10% this year but was up 170% in 1999. He notes that the funds don't have high risk and volatility ratings, even though he thinks their strategies are fairly aggressive. But he does warn that expenses are high, and annual turnover at several of the funds has been running at an extremely high 500% of late.

PROMISING CORNERS. So where are the funds investing, at least for the moment? Video-game makers like Electronic Arts (ERTS) and Take-Two Interactive Software (TTWO), both up this year, represent one area that has been working well.

Driehaus also has high hopes for low-cost airlines, such as JetBlue(JBLU), Ireland's Ryanair, and the Britain's easyJet. The firm is also buying some managed-care stocks, like WellPoint Health Networks (WLP), and generic-drug makers, including Teva Pharmaceuticals (TEVA) and Forest Laboratories (FRX). For-profit education companies, like Apollo Group (APOL) and Corinthian Colleges (COCO), are another group that's working well in 2002.

Energy is being emphasized this year, partly because of the sector's defensive characteristics. Most of the picks are in exploration and development, including Ultra Petroleum (UPL), Murphy Oil (MUR), and Amerada Hess (AHC).

RUSSIAN OIL PLAY. As far as technology goes, Andrew Rich, who manages a separate account called Small Cap Recovery Opportunities, pointed out that the tech outfits seeing growth are mostly selling to the U.S. government, their products being mainly used for intelligence-gathering and defense. He highlighted Applied Signal Technology (APSG), Mercury Computer Systems (MRCY), Viasat (VSAT), and Orbital Sciences (ORB).

Abroad, the funds have found pockets of strength where the consumer is becoming a growing force and the investing environment is stabilizing. Eastern Europe -- Russia in particular -- is attractive, according to portfolio manager Svein Backer. One investment he favors is AO Yukos, the second-largest Russian oil company.

In probably the most telling sign of how the fund managers really feel about the market, they also highlighted short-selling -- a way to turn a profit from stocks as they decline. Portfolio manager Jeffrey James is becoming DCM's expert on this strategy, which he says can both increase returns and reduce risk in volatile markets.

MORE LIKE "201(k)s." Past short positions that have worked well include VeriSign (VRSN) from November, 2001, to this July, and Atlas Air Worldwide (CGO) from March to July. None of the mutual funds is allowed to use the strategy, and James declined to discuss his current short positions.

Clearly, Driehaus is cautious on the U.S. and Europe, where the economies seem to be getting weaker. Richard Driehaus thinks the Federal Reserve is likely to cut interest rates again this year. Market sentiment is worsening, he says, noting that investors no longer rush to buy on the dips. Qips Driehaus: "401(k)s have been turned into 201(k)s."

Nonetheless, Driehaus argued that investing in volatile stocks is a less risky strategy than it seems. To leave money on the sidelines in bank accounts is to guarantee weak performance. If you rush to housing and bonds, you could be buying at the top. Instead, he says investors should buy stocks that will benefit when the economy turns around. His mantra: "You need to embrace risk to take advantage of volatile markets." Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column


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