Good Things in a Small Package

What sort of fund flows and cash levels do you see? Olsson: We really don’t try to time the market, because we don’t know how to do that. We aim for about a 5% cash level. But it does depend on which day you look at it, because the fund has been so small, and from time to time we have gotten a significant inflow on a particular day.

How growthy or expensive are the holdings you own, given that Europe is cheaper than the U.S., especially for small caps, but also that you’re clearly on the growth half of that market? Holzer: Over all, European small caps are trading at about a 30% discount on price-to-book and about a 20% discount on price-to-earnings to the large caps. Now for our fund, just to give you an idea of that profile, the median expected growth rate for the next 12 months is 25%, and that compares to a median next 12 months’ P/E of 16. These are IBES numbers, and I think that’s a pretty good profile. From our standpoint we are basically finding growth companies at very attractive valuations in this universe.

Stocks that come to mind? Holzer: One of the things that’s been nice is that some of our largest holdings have been the best performing stocks. We can speak freely about any number of them. But one area that has worked well for us this year is the consumer area, both on the discretionary side and the consumer staple side. You have things like Puma and Merloni [Merloni Elettrodomestici makes household appliances], obviously consumer discretionary. Puma is a well-known company, great order momentum, great earnings momentum, cheap relative to Adidas and Nike, the big companies. It’s about a $1.1 billion market cap. I think that gives you an idea of the brand power relative to the size of the company. It has been a great performer for us, and it continues to show pretty terrific momentum. As with all fashion-oriented stocks you have to be very nimble, but for the time being everything looks bright.

Does your fund complement a position in, for example, the iShares S&P 350 IEV? Holzer: Yes, and for anyone who is heavily invested in the U.S., this would have minimal correlation to the S&P and, I would venture to guess, minimal correlation to the vast majority of mainstream international funds out there. It’s a good diversifier in that respect. You are getting into stocks that aren’t found in but 1% or 2% of funds out there. On paper, the fund will seem to be more aggressive than a European fund, which would in turn be more aggressive than a diversified international fund. But the actual experience is that the fund has not really been all that volatile. That could change over time. I think the fund is suited for someone who is comfortable with foreign investing and wants a differentiated niche.

What does the lack of small-cap Europe funds tell you about the market for this niche? Is it too exotic? Holzer: At first blush, yes. But when you place the idea of the European small-cap fund in the context of how large Europe is, and how deep the equity markets are there, and when you think about how many U.S. small-cap funds there are, it doesn’t look so exotic. And I would venture to guess that over time, as people here return to foreign investing, you’ll see more of them.

Do you think there is an argument to be made that Europe is too stodgy, and thus the small-caps would precisely be the areas of most interest, and one might want to bypass the large caps altogether? Holzer: Absolutely. Plus the fact that, in this market, the odds of something that we own showing up in a scandal article on the front page of the Wall Street Journal, as opposed to all of the large-cap stocks out there, is tiny. You’re talking about simpler-to-understand companies, typically higher management ownership, greater transparency.

They’re not conglomerates, and they haven’t been growing through frequent takeovers. Holzer: Exactly. Another angle is that a lot of U.S. commentators now are pushing large caps versus small caps domestically, because of the currency, saying that it’s the larger export-oriented multinationals that can take advantage of dollar weakness in seeing an export benefit. The exact reverse is true in Europe, where euro strength is to the benefit of small caps vs. large caps. These tend to be more domestically oriented companies. The main small-cap points: Under-valuation, unique opportunities, currency benefit, non-correlation to major markets and funds. It’s interesting from many different viewpoints.

Let’s hope it’s profitable, too.