Even in the world of small-cap stocks, the companies in the Wasatch Micro Cap Fund (WGICX) are on the diminutive side. The 50 to 80 holdings in the portfolio have a median market capitalization of $689 million, and chances are you’ve never heard of most of them.
But what these companies lack in size they more than make up for in quality and staying power, says fund manager Ken Korngiebel, who has mined the small and micro-cap universe for nearly 25 years. Unlike many companies in the micro-cap space whose financial profiles are less than impressive, those in the fund’s portfolio typically have healthy low-debt balance sheets and the potential to grow sales and earnings at rates significantly better than those of companies in the benchmark index. For the most part they’re profitable industry leaders mostly able to self-fund their growth without much debt or high fixed costs.
“Those kinds of companies may be positioned to withstand periodic Covid-related challenges and emerge from the pandemic even stronger with increased market share,” says the 55-year-old manager. “And because most of them are focused on domestic economies, they should have fewer challenges if global supply chains and worldwide demand are disrupted by Covid-19 for an extended period.”
The Case For Active Management
It’s no secret that actively managed large-cap funds have a tough time beating the performance of lower-cost indexed ETFs or mutual funds. In that space, finding undiscovered gems and overcoming the hurdle of high management fees is a steep climb.
But Korngiebel says the same does not necessarily hold true among small and micro-cap stocks, an area where active managers have a better shot at uncovering less obvious investment opportunities. And the companies that populate these indexes often have vastly different financial profiles. “Micro-cap indexes certainly contain many unprofitable companies that are likely to remain micro-caps,” he says. “That is one reason why indexing typically doesn’t work in this space.”
Wasatch, a small company stock specialist, screens for companies with growing revenue and other superior financial attributes. With the exception of a handful of biotech names, which traditionally plow money into research and development but generate little or no revenue, the companies in the portfolio are profitable.
Nearly a quarter century of mining this segment of the market has provided Korngiebel with a network of valuable industry contacts that include private equity investors, venture capitalists and corporate executives who have a track record of success at previous companies. He’s even had a former investigative journalist on retainer to conduct due diligence and interview the former employees of the stock issuing companies to get a better picture of what the insides of the companies look like.
The fund’s independent streak is evident in its 95% active share (the measure of how much it differs from its benchmark). Both the average and median market capitalizations of the companies in the fund are much larger than those in the bogey, while the portfolio’s higher price-earnings ratio reveals its focus on more rapidly growing companies. The fund has emphasized the growth style, which has trumped value in recent years, and that has also helped push its performance past that of the benchmark. The goal, says Korngiebel, is to double investors’ money every five years.
The fund’s performance also bears little resemblance to the benchmark Russell Microcap Index. As of May 31, the Wasatch fund’s institutional class shares were up 23.71% over one year, while the index declined 4.78%. Fund shares rose an annualized 23.66% over three years, 16.30% over five years and 15.57% over 10 years. Over the same time frames, the index rose at an anemic annualized rate of 0.52%, 2.06% and 8.31%. Over the last five years, the fund has captured 98% of the index’s upside returns, and only 77% of its downside.