Small-Stock Managers Still Top the Charts WINNERS’ CIRCLE
By SuzanneMcGee “I haven’t been nearly optimistic enough—that’s been my problem,” says Alex Ely. Mr. Ely, manager of Delaware Smid Cap Fund (DFCIX), is the No. 1 stock- fund manager after outpacing the managers of the other small-cap and midcap growth mutual funds that once again dominated The Wall Street Journal Winners’ Circle rank- ings. For the 12 months ended Sept. 30, Mr. Ely’s fund posted a return of 58.7%. (The name of the fund, which has $1.67 billion in assets under manage- ment, uses “Smid” to mean small and midcap.) Back in the second quarter, the fund came less than a quarter of a percentage point from winning then, too, with a gain for that rolling 12-month period of 43.9%. Still, Mr. Ely figures that this is just the start of something good. “We believe we are in the early innings of a significant expansion in the equity markets,” he contends. “People generally are too negative about the markets. They are worried about the end of the expansion of a cycle; worried that valuations are too high.” For his part, Mr. Ely increasingly thinks that valuations are “fair” and that there are significant opportuni- ties as many big industries undergo upheavals. “If you can be early, in a company that is a major leader in one of these trends,” he says, “there are lots of prospects for you to make outsize profits…as these big businesses find better ways of doing things.” In his view, that is what is really driving the outperformance of small- cap stocks that has been such a feature of themarket for most of 2018.
“They are insulated from the trade war, and protected from interest rates rising” since smaller companies tend to carry less debt. (Ms. Zhang also seeks out those businesses that are less dependent on the capital markets when hunting for new investment ideas.) Smaller companies also bene- fited from the tax overhaul to a greater extent than their larger counterparts (which frequently already had found ways to cut their effective corporate tax burdens) and have strategic value as merger and acquisition targets as big companies have cut back on internal research and development spending. That doesn’t mean that the small- cap arena won’t be a volatile one, even for top managers like Mr. Ely and Ms. Zhang. “Companies don’t grow in a straight line, but we use market volatility as our friend; as a chance to buy more of good companies on market weakness,” Ms. Zhang says. Mr. Ely says that a correction is possible at any time, and that—based on historical trends—a bear market in small-caps could hit in the next two to four years. That still doesn’t worry him. That correction, he says, “will be very similar to that of 1990-91, a softer one, that doesn’t disrupt the positive secular trends.” He also notes that small stocks have already endured one bear market, at least on a relative basis, lagging far behind the S&P 500 in 2015 and 2016. For now, Mr. Ely and Ms. Zhang are far more interested in the fundamentals of the companies that they expect to drive their portfolio returns than they are in themacro environment. One of Mr. Ely’s big winners was Weight Watchers International Inc., a stock he bought at $23 and began to sell as it hit $90. He liquidated the position
In every Winners’ Circle contest, we identify those actively managed U.S. stock funds that have at least $50 million in assets and a record of at least three years, and highlight the fund with the best performance over the previous 12 months, based on data from Morn- ingstar Inc. It is not common for a single cate- gory of funds to dominate the top dozen funds or so in the Winners’ Circle rank- ings quarter after quarter. But that is what has happened this year, when it has been small, growth-oriented stocks, all the way. Even now, after many small-caps were in the red for September, the top- performing managers in the Winners’ Circle remain unflappable. “I think there are still a lot of tail- winds for small-caps,” says Amy Zhang, manager of the $2.3 billion Alger Small Cap Focus Fund (AOFIX), which came in second, with a return of 51.9%. Amy Zhang, manager Alger Small Cap Focus Fund. PHOTO: FRED ALGER MANAGEMENT
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as the shares approached $100, but has now started to repurchase them as the price has fallen again. The company is changing its legal name to WW Inter- national Inc. as it emphasizes “healthy eating,” not just dieting, and—crucial to Mr. Ely—has shifted its business to a mobile platform, helping clients and employees connect online. “Its market is now global.” He expects that Take-Two Interac- tive Software Inc. will continue to be a big winner, based on the same theme of individuals changing the way they interact and opting to connect online. In this case, those people are gamers, and Mr. Ely says he doesn’t want to under- estimate the addictive value of games created by highly educated software engineers. We’re consuming health care in a different way, and Mr. Ely thinks companies like BioTelemetry Inc., whose stock has more than doubled
over the past 12 months, will continue to grow along with the use of its mobile cardiac-monitoring devices. He’s also taking stakes in cannabis companies: Canopy Growth Corp. of Canada (Mr. Ely says he was encouraged by a $4 billion investment made by drinks company Constellation Brands Inc. this summer) and GW Pharmaceuticals, the first cannabis company to have one of its medical products approved by the Food and Drug Administration for even limited uses. “These all are companies that have dramatic growth potential, that are leaders—and mostly that remain chron- ically undervalued,”Mr. Ely says. Ms. Zhang seeks to identify compa- nies with a large competitive moat and the potential to see their revenue growth double over the next three to five years. She has found interesting candidates in health care, including Veeva Systems,
a cloud-computing business delivering solutions to pharmaceutical and life- sciences companies. “People didn’t believe that they could grow as fast as they have; that [customer relationship management] was going sideways,” she says. Veeva has rolled out a series of successful products, has more on the way and is starting to move beyond life sciences, she notes. “They have no debt, high-quality revenues and high margins.” While there are justifiable doubts about the worth of active management, Ms. Zhang says she likes her fund’s chances as she continues to pit her stock-picking skills against small-cap index funds. “The small-cap world is a very fertile one for active manage- ment,” she says. Ms. McGee is awriter in NewEngland.
This article reprint, originally published by The Wall Street Journal on October 5, 2018, is considered sales literature for the Alger funds mentioned only and not for any other products shown. Please note that The Wall Street Journal is an independent publication and the performance and ratings cited in the article do not represent the experience of any individual investor. For the period ending September 30, 2018, the Alger Small Cap Focus Fund (the “Fund”) returned the following:
Average Annual Total Returns (%) (as of 9/30/18)
3 Years 5 Years 10 Years Since Inception
Class I (Incepted 3/3/08)
Class Z (Incepted 12/29/10)
Russell 2000 Growth Index
Morningstar Percentile Rank (Small Growth) Based on Total Returns Class I