Markets & Finance

Seeking Returns at a Discount


Glenn Primack takes a moderate approach to investing in smaller-cap stocks for the $1.2 billion FMI Focus Fund (FMIOX). He and co-manager Richard Lane look for stocks trading at a discount to the underlying company's value, as determined by looking at the prices comparable outfits commanded when acquired.

Seeking upside potential at a discount has apparently helped the fund to somewhat limit the volatility of small-cap investing. FMI Focus' 24.37%

standard deviation is modestly lower than the 25.44% of the average small-cap growth fund. In addition, the portfolio has a substantially lower

turnover rate (52.6%) relative to the peer group's average (151.4%). FMI Focus also has the added advantage of a lower

expense ratio than its peers, 1.47% vs. 1.74%.

While the fund generally focuses on small-caps, it now favors midcap stocks, as reflected by its $9.5 billion median market cap. The managers are stressing midcap stocks because they feel small-caps have already enjoyed strong gains. Presently, the fund is overweight in the energy and media sectors.

TOP RATING. Long-term, the fund has significantly outpaced its peers, while its recent performance has been competitive. For the five years through Feb. 27, the fund rose 19.8% (annualized), compared with a 6.8% gain for small-cap growth funds overall. For the one-year period through February, the fund was up 59.9%, vs. 58.5% for its peers.

Based on risk and return characteristics during the last three years, Standard & Poor's gives the fund its highest overall rank of 5 Stars. Bill Gerdes of S&P's Fund Advisor spoke recently with Primack about his strategy. Edited excerpts from their conversation follow:

Q: What are the fund's investment goals?

A: We look for stocks trading at a discount to the private market values of the underlying companies. We determine a company's private market value by looking at mergers and acquisitions of comparable companies. We then see which companies are trading above and below their private market values. In addition to attractive valuations, we also look for companies with strong earnings growth and good managements.

Q: How do you follow a focused strategy?

A: When the fund started, we had 30 to 40 holdings, but over time we've moved up to about 90 holdings. We're focused in terms of industries.

With respect to sectors, we're overweight in energy and media. We like the media industry because companies with overcapacity will be looking to differentiate their products through advertising. We like energy because of the growing global economy. It's also a play on China, where energy demand is increasing.

Q: How did recent disclosures that certain major oil companies substantially understated the size of their oil reserves affect your view of the energy sector?

A: This issue has opened up Wall Street's eyes -- these revelations could trigger more consolidation in the industry.

Q: Do you avoid any sectors?

A: We don't have any tobacco stocks. In the past, we didn't have a lot of retail, but then we had some success in retail as we understood the sector better.

Q: What's the fund's approach to market capitalization?

A: We look for small- to midcap stocks. We're generally about two-thirds invested in small-caps and one-third in midcaps. We won't sell winning small-cap stocks that rise to midcap status. Our median market cap is about $9.5 billion, so we're currently leaning toward midcap stocks, where we're finding more opportunities. Small caps have already had a big run.

Q: Have the cutbacks in analyst coverage affected investing in small- and midcap stocks?

A: It has led to more opportunities -- but also more volatility. If you pick a good small-cap stock and they deliver, they're going to get coverage.

Q: Why does the fund have solid long-term returns?

A: All my equity investments are in the fund, as are substantial portions of the equity investments of Richard Lane and of our friends and families. That pressure keeps us focused.

Q: What are the fund's largest holdings?

A: They include Ingram Micro (IM), Casella Waste Systems (CWST), UNOVA Inc. (UNA), Emmis Communications (EMMS), Young Broadcasting (YBTVA), and Noble Energy (NBL).

Ingram Micro is a distributor of information-technology products and services for startup companies. It was trading at depressed multiples.

Casella Waste Systems is a small regional waste-disposal company with a niche market in the Northeastern U.S. After acquiring companies outside their core business, they've since been refocusing on their core business.


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