Liquidity is a problem, but microcaps can offer good value.
By Charles Keenan
June 2002
Just 12 funds appear in Morningstar’s ranking of institutional microcap funds, but their recent gains certainly underscore the case for investing in smaller companies. The group returned 14.4 percent in 2001, versus a 1 percent gain for 234 institutional small-cap funds and a 14.3 percent loss for their 611 large-cap counterparts. Up slightly through mid-May, the funds have continued to leave their small- and large-cap brethren in the dust.
As defined by Morningstar, microcap stocks have market capitalizations of $250 million or less. Assets for the small group of funds investing in them rose 32 percent last year, to $3.5 billion. That compares with a 16 percent rise, to $40.8 billion, for institutional small-cap funds, and a 5.7 percent drop, to $221 billion, for large-cap funds.
Given the recent rush to value, it’s no surprise that the top microcap funds all focused their attention on that portion of the market. The top three institutional funds: Boston Partners Small Cap Value II Institutional Fund, up 47.9 percent last year; DLB Small Company Opportunities Fund, up 30.7 percent; and DFA U.S. Micro Cap Portfolio, up 22.8 percent. Through mid-May they had notched gains of 6.8 percent, 3.1 percent and 7.6 percent, respectively.
The managers of the three funds have done well buying little-known, undervalued companies whose stocks are reasonably liquid. They often look for an earnings catalyst that could make the shares take off. “We buy them cheap, when we think they can dramatically appreciate,” says Paul Szczygiel, manager of DLB Small Company Opportunities.
Recent stock picks include Rye, New York,based Alltrista Corp., a maker of home canning jars and plastic products. Szczygiel bought shares in January at $19 following a management change and improved profit margins. The stock recently traded at $36.
Szczygiel also likes Methode Electronics, a suburban Chicago manufacturer of electrical components for automobile steering columns that recently started picking up new business in Europe. He bought shares in the first quarter at about $9; the stock recently traded at $11.
Of course, microcaps are far less liquid than even small-cap stocks. “A little bit of buying can move these stocks up pretty quickly,” says Dan McNeela, an analyst at Morningstar. “With a large institutional investor, it can be hard to put all that money to work in the microcap area.” As a result, many managers accumulate or sell off a position slowly, over the course of a few weeks even, as opposed to a single day.
Some institutional investors sidestep the liquidity problem by investing in an index fund, such as the $1.7 billion DFA U.S. Micro Cap, which had asset inflows of $284 million in 2001, according to Morningstar.
Managers of microcap funds appreciate the fact that small companies are not well covered by sell-side firms. “You get to know these companies better than anyone on Wall Street,” says David Corbin, manager of Corbin Small Cap Value Fund. Corbin,s retail fund, with $28 million in assets, returned 54 percent in 2001.
These days many microcap fund managers argue that the stocks that make up the Standard & Poor’s 500 index are overpriced. They traded recently at an average of 43.6 times trailing 12 months earnings, versus 25.7 times for microcap stocks.
Institutional funds scoreboard
Morningstar has ranked the following as last year’s top ten microcap stock funds.
Assets
Total return
Total return
5/10/02
calendar year
year-to-date
Fund
($ millions)
2001
5/10/02
Boston Partners Small Cap Value II Inst,l
$65.00
47.86%
6.77%
DLB Small Company Opportunities
410.5
30.69
3.07
DFA U.S. Micro Cap Portfolio
1,669.70
22.77
7.59
Munder Micro-Cap Equity Y
12.6
16.62
1.72
Munder Micro-Cap Equity K
5.5
16.32
1.66
Deutsche Micro Cap Inst,l
63.6
15.37
,5.13
Pimco Micro Cap Inst,l
256.3
10
7.68
Pimco Micro Cap Admin.
33.8
9.67
7.59
Fremont Institutional U.S. Micro-Cap
352.3
7.52
,12.39
First American Small Cap Value Y
523
5.21
10.97
Brazos Micro Cap Y
304.3
4.7
,11.47
BlackRock Micro-Cap Equity Inst,l
26.3
,13.95
,14.97
Source: Morningstar.
