With the emergence of the Russell Microcap Index this summer, the first index of its kind, the somewhat ignored micro-cap sector may finally attract some interest from investors. One of the newest entrants into this space, the Touchstone Micro-Cap Growth Fund/A (TAMCX), focuses on attractively valued stocks delivering high earnings growth.
Portfolio managers O. Thomas Barry III and Stephen Shipman of Bjurman, Barry & Associates use a proprietary quantitative research process to screen a universe of about 1,900 stocks — with market caps between $30 million and $300 million — and whittle them down to ultimately form a portfolio of between 70 and 90 holdings.
The $64.3-million fund gained 22.0% for the 12-month period ended September 30, versus a 17.8% for the average small-cap blend fund. Launched in June 2004, the fund does not have the three years of operation necessary to receive a Star ranking from Standard & Poor’s.
The drawbacks inherent in micro-cap investing are well known: Shares of these firms are often illiquid and volatile. To address these risks, Bjurman, Barry & Associates seeks strong diversification. No individual holding can represent more than 5% of the fund’s total assets, and no industry, as opposed to sector, can account for more than 15% of the pie.
On the other hand, Shipman noted, micro-caps offer great advantages as well. Since most micro-sized firms remain unknown to the general public and receive little coverage from Wall Street, they tend to be inefficiently priced. As a result, micro-caps can climb dramatically in value in a relatively short time, typically driven by rapid earnings growth.
As of September 30, the fund’s top sectors were health care, 27.2%; information technology, 23.4%; industrials, 19.9%; consumer discretionary, 15.7%; and consumer staples, 7.5%. There is very little exposure to financials and energy. Health care and information technology dominate the fund, Shipman said, because they represent the fastest growing segments of the economy.
The ten largest holdings as of that date: NutriSystem Inc. (NTRI), 2.9%; Hansen Natural (HANS), 2.6%; Forward Industries (FORD), 2.6%; Dynamic Materials (BOOM), 2.4%; IRIS International (IRIS), 2.3%; LoJack Corp. (LOJN), 2.3%; American Dental Partners Inc. (ADPI), 2.2%; CNS Inc. (CNXS), 2.1%; True Religion Apparel Inc. (TRLG), 2.1%; and Charles & Colvard Ltd. (CTHR), 2.1%.
One of the fund’s top holdings, Hansen Natural, a maker of health drinks, typifies the type of company the fund managers like to buy. “This is a true winner. Its market cap has soared from about $250 million to nearly $1 billion now,” Shipman said. “Hansen’s ‘sports energy’ drinks have become so popular that now even Coke and Pepsi are getting involved in this business.” Hansen’s stock price has more than doubled since the year began.
Another favorite stock, Iris International, manufactures software for the imaging of microscopic surgical procedures. “Last year, Iris earned $0.25/share, and its bottom-line is expected to grow by 40%,” he said. The company’s shares have also doubled year-to-date.