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Fund in Focus: Keeley Small Cap Value

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Sept. 21, 2004 — John Keeley agrees that his approach to investing is “unusual.”

The companies that the portfolio manager buys for the Keeley Small Cap Value Fund (KSCVX) fall into five categories, including those that have just recently emerged from bankruptcy, been spun off by other companies, or whose stock is trading well below the firm’s book value.

He also keeps an eye out for savings and loan associations and insurers that have converted to public ownership. These companies are particularly attractive because they are likely to be acquired, Keeley says.

Another group consists of what Keeley calls “busted” utilities, that is, those that return to their core power businesses after unsuccessful attempts at branching out into other operations.

All these stocks tend to be cheap, says the value-oriented Keeley. “So if we make a mistake, and we do make mistakes,” he says, the result is not as “painful” as seeing a high-priced share fall.

“It’s an unusual method of investing,” Keeley says of his style. “But on the other hand I don’t think it’s any riskier than anything else.”

Keeley has kept his $190-million fund ahead of its peers and the Standard & Poor’s 500 index recently, and over the long run. The portfolio was up 8.7% this year through August, versus a gain of 2.4% for the average small-cap value fund, and 0.4% for the index. Keeley Small Cap Value returned 15% on average for the ten years ended last month. Similar funds advanced 12.7%, and the S&P 500 climbed 10.7% in that period.

The fund’s results also have been more stable than its competitors. Its standard deviation, a measurement of the variability of returns, clocks in at 16.25, compared to its peers’ 18.38. And the fund’s beta, which indicates sensitivity to changes in the market, is 0.78, versus its peers’ 0.90.

The fund manager emphasizes that he avoids volatile technology stocks because they can be expensive and because he has difficulty analyzing them. That these companies’ products can have short lives does nothing to make them more desirable, he adds.

In picking the approximately 115 stocks that go into the portfolio, Keeley focuses on companies with strong cash flow, relatively low debt, and sales that exceed market capitalization. He hunts for investments among companies with caps of $1.5 billion or less.

Stocks that aren’t widely followed by Wall Street pique Keeley’s interest, too, because they can appreciate when mainstream analysts begin tracking and touting them.

One of Keeley’s favorite stocks is Conseco Inc (CNO), an insurance company that came out of bankruptcy a year ago. Keeley invested in the company about nine months ago. Conseco’s shares are relatively inexpensive, and the company has a tax-loss carryforward that can improve its bottom line and make it look good to a potential buyer, he says.

Another stock Keeley likes is homebuilder Levitt Corp`A` (LEV), a subsidiary of BankAtlantic Bancorp (BBX) that it spun off last December. Levitt features a “terrific backlog” of orders and attractively priced stock, Keeley says. He expects Levitt, whose stock has been trading for about $22 lately, to earn about $3.30 per share next year.

One of the fund’s top holdings is EnPro Industries (NPO), which makes industrial products like compressor systems. Keeley thinks the company can generate earnings of $2.40 per share.

Another of the fund’s major holdings is Comfort Inn franchiser Choice Hotels Intl (CHH). The company churns out cash and its earnings are growing at a better than 30% clip, according to Keeley. The fund manager also applauds Choice’s dividend, which it raised by 12.5% to $0.225 per share last week.

When it comes to selling, Keeley will reduce a holding or eliminate it from the portfolio if a stock becomes pricey, or the company’s financial picture darkens. Keeley looks to stay invested in a company for three years or more, and his fund gets a makeover less frequently than similar offerings. Keeley Small Cap had a turnover rate of 38.8% last year, compared to 70.1% for its peers.

The fund has a 0.25% marketing and sales, or 12b-1 fee, and its shares carry a 4.50% sales charge. Its expense ratio of 1.75% is higher than its peers’ 1.53%. But Keeley says the fund’s expenses have been decreasing, and he expects them to decline further as its assets increase.

Keeley, who oversees the fund with the assistance of three analysts, is a shareholder in it as well. His stake accounts for about 8% of the fund’s assets.

Contact Bob Keane with questions or comments at: [email protected].