Experience Counts

Throughout his career, fund manager Thomas Barry has worked through market times when every investor felt they were so deep under water they’d never again surface, and times when every investor felt they were flying so high they’d never again touch down. Those experiences keep him well grounded amid today’s challenging market conditions.

His take on the subject of handling the exuberant and the depressive times: “You make more rational decisions [when you've been through a number of bear and bull markets]. You get concerned, but you don’t get scared at the bottom. You realize that when you’re most concerned, when all the negative news is hitting, that is the time to buy stocks.”

After being in the investment business for more than 30 years, Barry, the CIO, senior executive VP, and senior portfolio manager of Los Angeles-based Bjurman, Barry & Associates, knows a thing or two about picking investments. “I don’t like bear markets, but you realize you can get a great sale like you do at Christmas,” he says. “You can buy stocks at half price. Most people sell when [the market] hits the bottom, but that is the worst thing you can do. That is the irrational investor; it’s the emotional investor taking over rationality.”

As manager and founder of Bjurman Micro Cap Growth Fund (BMCFX), Barry’s stock-picking philosophy has not gone unnoticed–the fund has been awarded five stars by both Morningstar and S&P, and is the top fund in its peer group of 304 funds, according to S&P. “Most people want to hold on to their losers because they don’t want to acknowledge that they made a mistake,” he says. His philosophy: hold onto the winners as long as they’re good, and get rid of the losers–and do it quickly.

Using a five-model screening process, Barry looks through a universe of 1,000 to 2,500 companies in the $30-to-$300 million market cap range for investments that meet his qualifications of EPS growth, cash flow/price, EPS strength, P/E-to-growth ratio, and EPS revision. “Each of these models might be used by other managers, but combining these models helps predict stock price movement and smooths out the down time [that one model alone might indicate],” he explains. “You can make decisions based on quantitative facts alone, but many times those aren’t going to make you better than anyone else. You have to adhere strictly and unemotionally to sale disciplines. Some of it is implementation and some is intuition, and many people follow their intuition in the wrong direction.”

Categorized by Barry as a growth fund that pays attention to price, BMCFX has outperformed both its benchmark and its category in both the short and the long term. For the five-year period ended July 31, 2002, according to Standard & Poor’s, Bjurman Micro Cap Growth Fund had an average annualized return of 22.4%, while the S&P 500 Composite Index had a total return of 0.4%, and all small-cap growth funds had a -1.4% total return. Moreover, the Bjurman fund ranked third within the entire universe of 3,341 funds in the domestic equity category on a total return basis, according to S&P.

Barry has seen his fund’s assets grow threefold since its inception in 1997, and after being closed initially on December 7, 2001, when fund assets reached $358.9 million, the fund reopened to new investors on May 1, 2002.

We spoke with Barry about the risky-by-reputation micro caps he chooses, about investors sticking it out through today’s less-than-predictable markets, and about the continued success of his fund.

You’ve been with this firm since 1978; how has that experience changed the way you manage the fund and control fund investors’ expectations? I think experience in going through bear markets in the past makes you realize when there is irrational exuberance and irrational glum. That is what experience does for you. You can just see it. There are a lot of numbers that help predict peaks and valleys, but when you have experience you just sense it.

By their very nature, micro-cap stocks tend to be riskier. How do you control that risk in picking your companies? We only emphasize companies that have very solid earnings growth, revenue growth, and products and services likely to continue to do well in the future. We limit [single] company purchases to less than 2% of the portfolio, and we don’t have more than 15% in any one industry. And lastly, we have a very strong sales discipline. Micro caps have really been less volatile than large-cap stocks over the last five years. Historically, small-cap stocks are more volatile, but when you adhere strictly to your investment discipline and even your sale discipline, you can reduce a great deal of that volatility.

Your sales literature says you seek “superior management capability” in each of your investments. How do you define that characteristic? It’s defined as how well a manager contributes to the bottom line relative to his peer group. Everything we do is according to the numbers. I can listen to the manager, a CEO, or a CFO of a company, tell me how great his company is, and how one should be impressed with the company, but if he isn’t delivering to the bottom line–meaning earnings growth and revenue growth–then I don’t consider that superior management.

Another characteristic you seek is “conservative accounting procedures.” Have the recent revelations of creative accounting procedures changed the way you look at companies in general? The news hasn’t changed the way we look at the small caps. There is a lot less small-cap companies can hide in their balance sheets. We have really not had anything in the small-cap market that even slightly compares to what is going on in the large-cap market. Small-cap companies are fairly simple. They have one product or a few products, or one service; they specialize in those services; and they don’t have many subsidiaries. So it’s very hard to hide items like they do in some of the large-cap companies.

Why do you use these five specific criteria–EPS growth, cash flow/price, EPS strength, P/E-to-growth ratio, and EPS revisions–in your screening process? Twenty-five years ago I was given the task of using whatever computers I could to determine what models worked best in predicting future price movements, and which models worked best in smoothing out the periods where one model didn’t work very well. I came up with these models. Seven or eight years ago I found that these models were showing many very small companies to be much better than many big companies. And yet we didn’t have a micro-cap product. All big companies form from small companies, and this is the feeding ground where you could actually find the future big companies. We decided to start a mutual fund, find all these [companies], and have some really good returns.

You limit your commitment to 5% in any one issue and 15% in any one industry. Over time, have you stayed consistently high in one industry or consistently low in another? I’d like to modify that just a bit. Five percent is the very maximum we will allow a stock to be as a percent of the portfolio. We have never been over 2.5% in any one company.

There are certain industries in which we have had long-term overrepresentation. The health care services industry is one, and the defense sector is another. Technology has traditionally been a stronghold of most growth managers, and we were very heavily invested in technology from 1997 to [early] 2000. In 2000, we significantly reduced our technology exposure. In our quantitative systems, [tech stocks] became highly overvalued relative to companies in other industries, like oil, finance, and health care. Health care and defense technology have been fairly heavily represented for some time. Even prior to September 11, we had a pretty healthy exposure to some defense stocks.

What is the average number of stocks held in the fund? It’s gone up from an average of 100 last year to 130 this year. The fund has grown from zero assets in March of 1997 to $275 million [now]. And to keep the diversification intact, you need to be able to buy more stocks. For every one stock I buy, there are others that look just as good. We could have more stocks in the portfolio but we don’t want to have too many.

So how do you decide which ones to include? If they meet all of our quantitative specifications, then I dig into what kind of products the company has. What is the consistency of earnings that they have had over the last five to 10 years? What is the likelihood, given the economic outlook, that they are going to continue to grow over the next three to five years? And relative performance of the stock price tells me plenty. If the company looks better on all of those criteria, or even slightly better, I would generally pick the one that has the best relative performance stockwise but still is undervalued on our screens.

There is a lot of intuition in this business. Everyone likes to get into the exact methodology. But when it comes down to it, picking out of four or five stocks that look relatively the same is somewhat intuitive.