Quick Take: Investors shouldn’t get too confident, says Grant Sarris, manager of Waddell & Reed Advisors Small Cap Fund/A (UNSAX). Heeding that warning, Sarris himself aims for a mix of stocks with various growth profiles, and limits each of his holdings to no more than 5% of the portfolio. The manager’s goal is twofold: avoid disasters during down markets, and perform in line with the market during upturns.
Based on the fund’s overall returns, Sarris seems to be meeting his objectives. This year through April, the fund rose 9.4%, versus a 4.1% rise for its small-cap growth peers. For the three years through April, the fund fell an annualized 6.6%, while its peers lost 17.3%.
The Full Interview:
S&P: What do you look for in small-cap stocks?
SARRIS: I try to buy smaller companies that can become a lot bigger in three years. Our turnover — currently about 25% — is low relative to other growth funds because of our three-year time horizon. In general, a low turnover strategy works best: The fewer decisions you make, the fewer bad ones you make.
S&P: How do you structure the portfolio?
SARRIS: I try to have a mixture of stocks with different risk profiles that is balanced, including some speculative stories with great potential, some out-of-favor stocks, and some steady growers. I never let a stock become more than 5% of the portfolio. Whenever you get that confident, you’re usually wrong.
S&P: You seem cautious about overconfidence?
SARRIS: Making a big bet on one company is a dangerous thing. I try to run a reasonably concentrated portfolio — about 50 holdings — but I don’t want one holding to stand out over everything else. A lot of times, your best ideas are the ones that you’re not that confident in. You won’t bet the ranch on them, but they end up working really well.
Our overall goal is to avoid disasters and keep people’s money when things aren’t going well. Then, we try for market performance when things are going well. I’ll probably always be a little more conservative than my brethren.
S&P: What’s your approach toward risk?
SARRIS: I’m a bit of a contrarian. If I feel investors are avoiding risk, I’ll take on a little risk, and if people are taking on too much risk, I may back off from risk and focus on steady growers. It’s impossible to judge risk, you have to feel it. You know if your portfolio is less risky if you can sleep at night.
S&P: How is the portfolio currently positioned?
SARRIS: I’m not drastically underweight in any major growth sector, though I’ve shied away from very cyclical areas. So, I’m a little underweight in industrials and technology, and a little overweight in energy. Energy is economically sensitive, but it has its own cycle. It can do well in a weak economy if supply is tight.
S&P: What do you look for in a potential holding?
SARRIS: Three characteristics are most important: the financial condition of the company, the quality of the profit margins, and the growth potential. In the late 1990s, investors only cared about growth potential. Lately, investors have only cared about financial viability because they didn’t believe anything could grow. Now, the market is favoring a combination of these factors. Going forward, the winners will be companies with decent balance sheets, the ability to finance growth, and growth potential.
S&P: How would you describe the market’s current stance toward growth?
SARRIS: We’re starting to see the market look more positively at growth. Investors are beginning to believe in companies with potential growth of 10% to 15% per year.
S&P: How would you describe the fund’s current growth profile?
SARRIS: Late last year, I decided to add a little more risk, which I think has been successful. Looking ahead, I’m still optimistic, even though the market has rallied in such a short period. We currently have a 14% cash position, but that’s because we’ve had large inflows. I expect our cash level will go down.
S&P: What’s you view of the market so far this year?
SARRIS: It has gone up awfully fast in a short period, so it will probably come back a little in the short term. A few times this year, the market has taken two steps forward and one step back. I expect that to continue.
S&P: What’s your outlook for the rest of this year?
SARRIS: I don’t think that growth rates will be very strong, but they will be positive. There’s been such a big downturn in the past few years that there could be okay growth rates off of this bottom.
S&P: What areas have the highest growth potential?
SARRIS: In health care, there are always good small companies that can become bigger. Consumer spending won’t be that great, but some consumer companies are likely to grow faster than the overall economy.