A Small Cap Fund with Big Returns

02/16/2009 11:08 am EST


Russel Kinnel

Editor, Morningstar FundInvestor

Russel Kinnel, editor of Morningstar FundInvestor, and analyst Katie Rushkewicz find one small-cap value fund that held up well in last year's market meltdown.

Allianz NFJ Small Cap Value (PSVIX) continues to impress. As ugly as 2008 was for equity funds, this Analyst Pick landed at the top of the small-value category.

The fund typically weathers market downturns fairly well-it posted one of the category's best records during the bear market of 2000 to 2003-and while the damage was magnified this time around, the fund's 27% loss in 2008 still outpaced roughly 90% of its peers. On the other hand, the fund's cautious tack can hold it back in bullish markets, as its lagging record in 1998 and 1999 indicates.

Overall, though, there have been more successes than failures, and the managers' disciplined approach has led to steady long-term performance. The fund's institutional share class, which has been around since 1991, boasts one of the best records in the small-value category. Its annualized 10.8% return since inception outpaces the Russell 2000 Value Index and trumps nearly all of its small value peers. [It also is] one of the least volatile in the category based on standard deviation of returns, suggesting that it offers investors a smoother ride.

A disciplined approach is what keeps this fund on track. Longtime manager Paul Magnuson and his team target dividend-paying companies that are trading at low price/earnings ratios. The team only buys stocks that are trading cheaply, but it is careful to steer clear of value traps by closely examining the financials of each company, avoiding ones with too much leverage and messy balance sheets. In fact, it focuses mainly on companies that pay steady dividends because it views this as a sign of financial strength.

This deep-value slant proved beneficial in 2008, limiting the fund's stake in the beleaguered financials sector to roughly half that of the Russell 2000 Value Index because the managers thought many of these stocks were overvalued.

Besides keeping the fund out of certain stocks all together, the process also provides strict sell guidelines. A stock is sold if it runs up in price, though it can be repurchased if its valuation becomes more reasonable (as was the case with grocery chain Ruddick Corporation). Quantitative models that monitor downward price momentum provide sell cues to rid the portfolio of weak stocks before they plummet even further.

That's not to suggest that the fund routinely bounces between stocks. It has a below-average turnover ratio and has held some stocks, like utility WGL Holdings (NYSE: WGL), for nearly ten years.

At 1.22%, the fund's expense ratio lands right around the median for no-load funds. The fee dropped slightly from its 2006 level of 1.25%. Although it's currently around the category median, it could be a bit lower.

Now that this impressive fund has reopened, investors would be wise to consider it.

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