Alger Small Cap Focus Fund Morningstar Analyst Rating
Inspired by Change, Driven by Growth.
Reprinted by permission of Morningstar, May 17, 2018
Alger Small Cap Focus Z AGOZX An upgrade to Silver.
Morningstar's Take AGOZX
expansion into related markets. These characteristics can make for attractive acquisition targets, and indeed the fund sees several takeouts each year. Zhang’s process courts considerable price risk as the firms she favors often have lofty valuations relative to their current earnings. On the other hand, their typically modest debt/capital levels lessen the likelihood of a blowup. Zhang won’t sell a name just because it hits a certain revenue or market-cap threshold. She will, however, trim positions once a stock comes within 10% of her price target and exit when her investment thesis no longer holds. Annual turnover has come down since Zhang overhauled the portfolio in 2015, notching 76% in 2016 and dropping to 45% in 2017, below the small-growth category average of 75%. Turnover will likely remain around this level or drop even lower. Amy Zhang crafts a best-ideas portfolio of roughly 40-50 stocks. Top positions typically take up 3%-5% of assets and are capped at 8%. That keeps security- specific risk in check to a degree, but with 30%-40% of assets in its top 10 holdings, the fund is among the more concentrated in the small-growth category. The fund stays rooted in cash-rich firms with competitive advantages that provide for continued growth, including expansion into other markets. Top holding Veeva Systems VEEV has benefited from businesses moving to cloud-based solutions, as it occupies a niche spot in the life sciences software industry. Such firms come at a cost, however. As of February 2018, the fund’s trailing P/E ratio was 51.1, more than double the Russell 2000 Growth Index’s 23.7. The fund’s heavy exposure to tech and healthcare stocks is notable, a characteristic shared with Zhang’s former charge. The two sectors dominate the portfolio, averaging around 80% of assets since Zhang took over, but even here, Zhang’s attention to
Zhang’s preference for cash-rich companies with several years of operating history has helped avoid stock blow-ups.
Morningstar Analyst Rating
True to the fund’s moniker, Zhang crafts a concentrated portfolio of 40-50 stocks and keeps roughly a third of the fund’s assets in the top 10 positions. Though turnover was high in her early days, attributable in part to the management transition, she invests with a three- to five-year horizon, and turnover dropped to 45% in 2017. Results have been solid with Zhang at the helm, and through April 2018, the fund soundly beat its Russell 2000 Growth Index benchmark, placing in the category’s top decile. The fund isn’t without risks, however. In addition to its sector concentration, it courts considerable price risks relative to peers, as Zhang’s preferred companies don’t come cheap. Indeed, the fund boasts some of the category’s highest trailing price ratios, though below-average debt levels provide some solace. Zhang’s strong start hasn’t gone unnoticed, as investors have begun pouring into the fund. Encouragingly, fees have fallen as the fund has grown and now provide an edge relative to peers. Investors seeking small-growth exposure should consider this option while it’s still open. Process Pillar ∞ Positive | Christopher Franz. CFA 05/15/2018 The fund’s revenue-centric, benchmark-agnostic approach earns a Positive Process Pillar rating. Rather than defining small companies primarily by market capitalization, which can be unduly influenced by investor expectations, manager Amy Zhang focuses on publicly traded firms with operating revenues of $500 million or less. She looks for those with healthy balance sheets, durable business models, and good prospects for long-term growth because their differentiated products or services satisfy emerging needs and enable
Role In Portfolio Supporting Fund Performance AGOZX Year
Total Return (%)
YTD 2017 2016 2015 2014
7.75 7.77 -2.72 4.70 -0.28
8.48 2.28 2.16
5-15-18 | by Christopher Franz. CFA
Increased confidence in Alger Small Cap Focus manager Amy Zhang and her supporting team and strong results since her 2015 start merit an upgrade in the fund’s Morningstar Analyst Rating to Silver from Bronze. Though Zhang took over in February 2015, she’s no stranger to small caps. Prior to joining Alger, she was a key contributor at Gold-rated Brown Capital Management Small Company BCSIX, helping to amass one of the small-growth Morningstar Category’s best risk-adjusted records over her 12- plus year tenure as comanager. Alongside four dedicated analysts, Zhang plies a similar approach here, focusing on firms with operating revenues of $500 million or less whose differentiated products or services satisfy emerging needs. This distinct, revenue-centric approach leads to a portfolio full of healthcare and technology names, comprising nearly 80% of the fund as of March 2018. Though this positioning presents obvious sector-specific risk,
Reprinted by permission of Morningstar, May 17, 2018
Kelly's Alger Capital Appreciation ALARX has also excelled, but the firm has had less success running other strategies. That could change, though. Proven small-cap manager Amy Zhang joined in early 2015, and Alger acquired Weatherbie Capital in early 2017 for its small/mid-cap growth expertise. Both Zhang and the Weatherbie team build benchmark-agnostic portfolios of about 50 stocks. These additions are promising, but Alger still has room for improvement. Fees are above average, and overall manager investment is weak. The firm receives a Neutral Parent Pillar rating. Price Pillar ∞ Positive | Christopher Franz. CFA 05/15/2018 This fund’s fees have dropped as it’s grown and now offer an advantage relative to small-cap peers, meriting a Positive Price rating. Manager Amy Zhang’s solid start hasn’t gone unnoticed. The fund has received steady inflows, including more than $150 million in 2018 through April. Fees have dropped as well and rank below average relative to comparably sold small-cap peers for most share classes. The A shares offer the best relative value; their 1.20% levy currently ranks in the cheapest quintile of small-cap, front-load funds. Assets have increasingly shifted toward the institutional Z share class; at 0.90%, it falls below the no-load median of 0.99%. A fee waiver on most share classes keeps the fund’s feesmore competitive than they would otherwise be, but Alger has indicated a willingness to keep costs competitive.
Prior to joining Alger and taking over this fund in mid- February 2015, Amy Zhang spent 12 years at Baltimore-based Brown Capital Management. There she helped Gold-rated Brown Capital Management Small Company BCSIX to one of the best records in the small-growth category, handily beating the Russell 2000 Growth Index with less risk. Zhang’s industry experience dates to the late 1990s, where she had a brief stint in credit derivatives before working as a global equity analyst at Templeton from 1998 to mid-1999 and then as a manager and analyst at Epsilon until she joined Brown in late 2002. While her experience is noteworthy, her personal investment in the fund is low, between $100,001 and $500,000. Zhang’s support staff has grown since she took over the fund and totals four dedicated analysts. Nidhi Chadda, a generalist with a background in consumer stocks, joined Alger in 2014 and began supporting Zhang in early 2016. Healthcare-focused Tom DeBourcy joined Zhang’s group in mid-2016 after joining Alger the year before. Zhang added software specialist Kyle Chen in 2016 and more recently research associate Caleb Huang from an internal training program. Though the supporting group’s tenure at Alger is short, they average 11 years’ industry experience. Parent Pillar ¶ Neutral | Christopher Franz. CFA 06/09/2017 Established in 1964 as a growth shop, privately held Fred Alger Management has overcome a great deal since the early 2000s. Its World Trade Center headquarters were decimated on 9/11, claiming the lives of most of the firm's investment staff, including David Alger, the founder's brother and manager of Alger Spectra SPECX, which Smart Money magazine praised as the most successful mutual fund of the 1990s. Alumni returned to help rebuild the firm, but soon afterward it was implicated in the market- timing and late-trading scandal of 2003. Alger settled those charges by 2007. With a bolstered compliance department, it has had a clean regulatory record since. Alger Spectra has returned to prominence, as it has consistently been a top-performing large-cap growth fund since manager Patrick Kelly took the helm in September 2004.
business fundamentals shows. She’s cautious about buying biotech firms, for example, because of their binary outcomes. The few biotech names she does own, such as Bio-Techne TECH and Repligen RGEN, feature low debt levels and generate positive cash flow. Though the fund does own some larger-cap stocks, such as mid-cap merchant platform Shopify SHOP, its average market cap is in line with the category. Performance Pillar ∞ Positive | Christopher Franz. CFA 05/15/2018 Manager Amy Zhang’s solid start, on both a total return and risk-adjusted basis, earns the fund a Positive Performance rating. Zhang took over in mid-February 2015, and through April 2018 the fund has returned nearly 15% annualized versus 10% for both the Russell 2000 Growth Index and small-growth category average. Risk-adjusted, the fund’s performance is equally strong; its Sharpe and Sortino ratios are comfortably ahead of the index and category average. These solid returns don’t come without risk, however. The fund’s massive healthcare and tech overweightings leave it prone to big swings in short-term performance whenever stocks in those sectors soar or sell off, evident in the fund’s bottom-quintile result in the sharp equity market correction from late December 2015 through mid-February 2016. Over the long haul, stock-picking should drive results here, as it did in Zhang’s 12-year tenure at Brown Capital Management Small Company BCSIX. That was the case in this fund’s 2017 result, where stock picks within Zhang’s favored tech sector (alongside the notable healthcare overweighting) led to a sizable gain over the fund’s bogy and average peer. Sector-specific and price risks notwithstanding, Zhang helped post superior results while keeping volatility in check at her former charge and has thus far demonstrated the same ability here.
People Pillar ∞ Positive | Christopher Franz. CFA 05/15/2018 A proven manager with extensive expertise in small caps earns the fund a Positive People Pillar rating.