Hidden Gem of the Small-Cap World

{Q} What kind of companies do you own in that space?

{Stellmacher} We focus on a company like Flotek Industries, Inc. [NYSE: FTK], a company that has come up with a chemical fluid that quickly extracts liquids in oil, making gas production faster. It’s environmentally friendly—it’s made out of orange peels, of all things.

{Q} Other ideas?

{Johnson} Rofin Sinar Technologies, Inc. [NYSE: RSTI]. It’s a capital goods company that makes industrial lasers. It’s a true growth company—lasers are taking the place of traditional welding and cutting. They’re gaining share in a high-growth industry. It’s a $45 stock, and the company has almost $5 of cash per share on the balance sheet. About 80 percent of sales are outside the United States, so they’re really benefiting from what’s going on in the growth in emerging markets.

{Q} What are you selling?

{Johnson} In general, we’ve taken a little out of cyclical areas—consumer and industrial—based on where we are in the economic cycle. We’ve sold Astec Industries, Inc. [NYSE: ASTE], a construction equipment firm, and Joy Global, Inc. [NYSE: JOYG], a coal mining equipment company. We have cut our position in Coach because the consumer is obviously slowing down [spending] a little bit.

{Q} With all the volatility that we’ve seen in the markets, how have you changed the way you run the portfolio?

{Sit} We pay much more attention to risk management than ever before. That affects your whole philosophy from top down to bottom up. We really learned some hard lessons from Enron and WorldCom.

{Johnson} Bottom line: When our analysts cannot get their arms around the downside of a situation, such as an accusation of fraud or a Securities and Exchange Commission investigation, we sell half of our position. We also never take sell-side analysts’ forecasts at their face value, as these are often pie-in-the-sky projections. We make our own forecasts and base price targets and valuations on our own work.

{Q} Has the risk profile—namely, the volatility of the fund—come down?

{Sit} Yes. In general, our portfolios have never been more diversified. It’s a riskier market, so our risk profile has come down. Our volatility with the Russell 2000 Growth Index is about the same. That index, in terms of standard deviation, is about 5 percent greater than the Standard & Poor’s 500. We’re not going to be the guy hitting a lot of home runs, but we hope to be getting on second base a lot.