A Volatile Fund with Hot Results


Money manager Joe Frohna looks for small companies poised for turnarounds for the First American Small Cap Growth Opportunities (FRMPX) fund. He often finds potential candidates among smaller-cap stocks because they're commonly overlooked by many investors.

Smaller-cap holdings tend to swing more in price than larger ones, which has boosted the fund's volatility relative to its peers. As measured by its 30.42%

standard deviation, the fund's volatility profile is moderately higher than the 26.73% average for small-cap growth funds.

Nevertheless, the fund has generated impressive returns recently and over the long term. For the one-year period through January, it rose 74.8%, vs. a 53.9% gain for its peers. For the five-year period through January, it was up 26.6%, on average, compared with a 4.5% rise for its peers. Based on risk and return characteristics over the last three years, Standard & Poor's gives the portfolio its highest rank of 5 Stars.

Frohna attributes these results to investing early in rising stocks, as well as combining

top-down and

bottom-up strategies. The manager looks for promising investment themes and then picks about 15 stocks in a sector likely to benefit from those trends.

Bill Gerdes of S&P's Fund Advisor recently spoke with Frohna about the fund's strategy. Edited excerpts from their conversation follow:

Q: What's your basic investment strategy?

A: We look for companies likely to grow 10% to 20%. They don't need to show this growth right away, but we like companies with a catalyst that will accelerate their growth. We'll take

contrarian positions before other investors catch on.

We look for companies with market capitalization of under $1 billion, although we'll go up to $2 billion. Most of our holdings have market caps of under $1 billion because that's a less efficient part of the market. We typically have 100 to 150 stocks in the fund.

Q: Why is the fund more volatile than the average small-cap growth fund?

A: Because we skew a little more toward smaller-cap stocks, day-to-day stock changes can hit us more as liquidity dries up. In periods of geopolitical stress, we can underperform.

Q: Do you consider any top-down trends in building the portfolio?

A: We use a theme-based approach because it reduces single-company risk. Rather than take big risks, we'll hold small positions in several companies. We'll cherry-pick about 15 positions within an area. At any given time, we'll probably have 10 to 11 different themes accounting for 60% of the portfolio.

We look for companies up and down the food chain in certain areas, and if their fundamentals are right, we'll invest in them. At the end of the day, a rising tide lifts all boats.

Q: What investment trends are you currently pursuing?

A: We're following the theme of flat-panel display, which will be a multiyear theme. We're also playing media, including radio and TV, because 2004 will be a good year for advertising with the Olympics. Because of new regulations, we see opportunities in transportation, particularly truckers and airlines.

Q: Why do you hold some industrial stocks?

A: Industrials is a cyclical area we're playing. At the end of the day, everything is cyclical. We started betting on industrials in August, 2002, feeling the economy would accelerate as President Bush was doing everything to stimulate it.

Q: Can you mention some other themes you've recently followed?

A: Recently, we had holdings in video games and software -- Activision (ATVI) and Electronics Boutique Holdings (ELBO). We put them into the portfolio in 1999 and 2000, and then started selling in 2002 and 2003 as the cycle peaked.

Q: Why have the fund's returns been competitive recently and over the long term?

A: Recently, it has been a good market for small caps, but in general, we've gained because we like to be early in a stock. I also attribute a lot to our investment process.

Q: What's your view of current valuations in the market?

A: Valuations are now fair, and I don't think anything is very cheap right now. Currently, health care looks good. Technology stocks are generally expensive, but growth is explosive, so you have to figure out how good earnings will be. We have reduced our tech exposure in the last two to three months. In small-cap land, you have to sell on the way down because things can go down fast.


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