The Needham Aggressive Growth Fund has built an impressive track record of index-beating results, but there are a few things about it that might seem contradictory. For starters, as of last year’s fourth quarter the fund’s largest holding was the most non-aggressive asset class on the planet—cash. And an “aggressive cash fund” sounds oxymoronic.

Also, consider the fund’s most recent annual report, where portfolio manager John Barr cites Charlie Munger as a big influence on his investment strategy. Munger, who passed away last year at age 99, was a noted value investor, perhaps best known as Warren Buffett’s right-hand man at Berkshire Hathaway. Munger wasn’t a poster boy for growth investing. (A Munger-style growth fund sounds oxymoronic as well.)

Finally, there’s the fund’s very low 7% turnover ratio. This, too, belies the image of an aggressive growth fund constantly turning over rocks in search of the next big thing.

Yet all these contradictions make sense within the context of how portfolio manager Barr thinks about investing and portfolio construction.

His fund, which he has managed since 2010, was recently awarded the 2024 LSEG Lipper Fund Award as the best of its 162 small-cap growth peers during the five-year period ended November 30, 2023. And the Needham fund’s average annual returns have made it the top-ranked name in Morningstar’s small-growth category in every time period from one year to 10 years (and it was fifth during the 15-year period, which Barr has mostly presided over).

Barr looks for companies with strong long-term growth potential and disruptive products or services, along with solid management teams. He also likes investing in companies that aren’t on Wall Street’s radar. In some ways, all of that seems like Growth Investing 101.

What sets the fund apart is the ability of Barr and Needham’s three-member research team to find early-mover companies in emerging business areas that have rapid growth potential. He then sticks with these companies long enough for them to live up to their promise. And if they don’t, he’ll eventually move on.

Barr believes the Aggressive Growth Fund has outperformed because he’s able to find “hidden compounders,” which he describes as companies making investments today that may see positive financial results beyond the forward-looking time frame of sell-side analysts. Such companies may look expensive in their current financials, he says, but the hope is that over time they’ll become “quality compounders” generating long-term returns.

He doesn’t expect to always hit the mark, yet when he does the winners can greatly aid fund performance. Still, this process can take time.

Take Super Micro Computer, the maker of server and storage systems that was recently the fund’s largest equity holding. Barr says the fund initiated its position in the company many years ago at $9 a share. He liked it as a play on data centers, which he and his fund’s parent, Needham & Company, have long been keen on.

Super Micro’s stock was a slow but steady performer before it hit a rough patch in the late 2010s, which Barr says hurt his fund’s performance. Then came the mania for artificial intelligence that began in earnest early last year. Investors identified Super Micro’s high-performance servers as a beneficiary of the AI boom, and its stock rocketed to more than $1,200 a share earlier this year before it dipped to about $1,000 by the first quarter’s end.

“The thesis was playing out on an incremental basis for years,” Barr says. “It was a 10% compounder but not on a consistent basis. It crossed from the transition stage to the quality stage about two and half years ago, and now it’s off to the races.”

Super Micro exemplifies Barr’s patient approach to investing—and explains the fund’s low turnover ratio. Or, as he self-deprecatingly puts it, “It’s tough for me to sell. I’m a good buyer and I’m a really good holder, but I’m not a good seller.”

He says he hits the sell button when his investment thesis for a company goes off track, and he won’t sell a stock just because its valuation has soared. “We have many ten baggers and above, and I’ve had some that reached that level and later retreated,” Barr says. “But those who’ve made that level are much more prevalent than those that’ve made the round trip.”

The fund’s success doesn’t come cheap, though, and its fee puts it in the most expensive quintile in Morningstar’s small-growth category. Nonetheless, Morningstar praises the fund’s ability to produce positive alpha for its category benchmark.

Qualitative Screen
The Needham Aggressive Growth Fund’s stated benchmark is the Russell 2000 Growth Index, but Barr doesn’t start in that universe when he’s hunting for names. “I’m very happy to find companies that aren’t in it yet,” he notes.

He explains that he and his team get plenty of ideas from industry contacts, as well as people they meet at various industry conferences, including his company’s own annual Needham Growth Conference, held in January in New York City. “We have nearly 400 companies presenting there, and our team can see a lot of them. That is a great source of ideas.”

Most of those ideas ultimately don’t pass the sniff test. Barr says he was a sell-side analyst before becoming a portfolio manager. Before that he sold the computer-aided design (CAD) software used in semiconductors and electronic systems design. He says his background has exposed him to a lot of companies, and that Needham’s forte in small-cap growth helps him and his team zero in on potential opportunities.

“It’s not a quantitative screen,” he says. “It’s more our industry experience and us just being around small-cap growth as part of our career.”

Part of Barr’s screening process hearkens again to Charlie Munger. “Munger preached the importance of investing in good businesses at a fair price, rather than fair businesses at a good price,” he says. He adds that Munger also stressed the importance of patience and compounding.

Barr’s value approach centers on investing with a margin of safety. His ideal company is one that’s investing in a new business area that could significantly expand its operating margins, even if the financials don’t show it yet. “We try to look over the horizon to find the new thing that will establish growth,” Barr says.

But he adds that it’s important for a company trying to enter a new market to have an established business that either generates cash or is profitable. Such legacy businesses protect a company if the new market has not played out as expected.

“We’ve had good downside protection historically,” Barr says. “I think it’s because of these legacy businesses and the margin of safety they offer.”

According to Morningstar, his fund has beaten its small-growth category peer averages on both the upside and downside during the past 10 years.

Potential Winners
One of the portfolio companies Barr has high hopes for is Aspen Aerogels, a maker of specialty insulation.

“You take a piece of this [material] that’s as thick as a piece of paper, put a blowtorch on one side and your hand on the other and you won’t feel the heat,” Barr says. “It’s a remarkable innovation. And it’s an established business with the energy industry with subsea pipelines, oil refineries and other industrial applications.”

He notes that a few years ago Aspen discovered its insulation could be used to prevent spontaneous combustion fires in lithium-ion batteries for electric vehicles. But he also likes that Aspen has a legacy industrial business that can subsidize the large capital spending requirements of its new EV-related business. And he notes the EV business has lined up potential customers such as General Motors, Toyota and several others.

“It’s a very big market, and the company is hardly known at all,” Barr says. “It’s starting to cross over into profitability, but we need General Motors to sell more electric vehicles. We don’t need them to sell as many as they’ve publicly talked about, but we do need EV adoption beyond Tesla.”

Another portfolio company with great potential, he says, is FARO Technologies, which makes high-precision measurement systems for industrial applications both big and small. Barr says the company previously overinvested in unrealistic growth plans that didn’t pan out. He believes that FARO’s new management team is targeting appropriate growth and investment.

“What’s attractive here is that FARO is valued at about one times enterprise value to revenue, and its industrial technology peers trade at four or up,” Barr says. He posits that the company’s current strategy could put it on the path to becoming a quality compounder.

Cash Is Temporary King
As of year-end 2023 cash represented a whopping 22% of the Aggressive Growth Fund’s portfolio. No, that’s not a misprint.

“We generally run more fully invested, certainly under 10%, and I love to be 3% to 4%,” Barr says. “But we’ve had significant inflows going back to the second half of last year. I steadily and regularly purchase positions after we get cash inflows, but the end result is still a lot of cash.” (The year-end figures were the most recently available when this article was written.)

Barr points out that most of the new capital is going into existing portfolio holdings that he says are in the hidden and transition stages, and which he believes are attractively valued or making more progress than the market reflects today.

“I get to add to those positions that are moving forward,” he says. “Without it, it would be only their natural appreciation that would carry them to be larger positions in the fund.”