Hidden Gem of the Small-Cap World

{Q} Small-cap growth has not done very well over the past few years. How have you been able to beat the index quite so handily over both long- and short-term intervals?

{Sit} We believe that earnings growth will lead to higher stock prices, and we concentrate on companies with strong long-term prospects. We also focus on a number of themes that have long-term significance for growth-oriented investors, such as health care, consumer trends, communications, and outsourcing.

We tend to be highly opportunistic in terms of identifying the sector where there’s a positive sea change in fundamentals. We are still a small enough firm that we can be nimble and position ourselves very quickly in those areas, such as energy, technology, infrastructure, or power generation. We find those companies benefiting from strong trends and take positions.

{Johnson} That’s our approach from the top down. But we also focus heavily on a bottom-up analysis. This is particularly true for our small-cap fund. About 70 percent of our efforts are concentrated in fundamental analysis and stock selection.

{Q} What are some of your sector bets?

{Johnson} Within capital goods, global infrastructure spending is one of our key themes. Not only in the United States, where we have things like highways and water systems and the power grid with long-term replacement needs, but also emerging markets, where lack of investment in these areas can be bottlenecks to economic growth. We also like the energy sector, based on our view that prices are likely to remain at high levels for quite some time. Finally, we favor the technology sector, although growth is not as broad based as it was a few years ago. We see the upside in companies benefiting from innovation in communications, such as voice over IP and wireless technologies.

{Q} What about individual stocks?

{Stellmacher} Early on in the energy cycle, we focused on the oil and gas exploration and production companies, because costs were low and their margins were expanding rapidly. In the aftermath of Katrina, there was a big spike in natural gas prices that spurred producers to go out and find projects that were cost effective at higher prices. That led to a big surge in demand in oil-field services, and after 25 years of puny returns, they were caught understaffed and short of capacity. This led to huge increases in the prices they could charge to the production companies. Now, we’ve seen a shift in profitability and margins from exploration and production to the oil-field service providers, and that has led to a shift from our emphasis on energy minerals—say, two years ago—to the oil-field services providers within the energy space.