It can be hard for a fund manager to remove a stock from her portfolio, especially when her choices were based on her strong convictions and she has a long-term focus.
That’s been a problem for Amy Zhang, who has mined the small-cap market for 18 years, managing the Alger Small Cap Focus Fund since 2015. She has at times had to sell her holdings when the companies she favored became so successful that their value soared, vaulting them into the mid-cap field where she could no longer get at them. Yet often, these maturing companies had ample room for growth.
To solve that problem—and establish a more decisive foothold in the mid-cap space—Alger launched the Mid Cap Focus Fund in June 2019. The fund’s track record is short but impressive. From inception through June 30, 2020, it was up 30.27% while the benchmark Russell Midcap Growth Index rose only 13.45%. For the year ending July 31, it captured 114% of the market’s upside and just 68% of its downside.
The fund has been so successful that Alger recently announced plans to launch an actively managed ETF, the Alger Mid Cap 40, in the first quarter of 2021. Zhang, of course, will be at the helm.
The performance of Alger Small Cap Focus, now closed to most new investors, provides a glimpse of her investment style and track record. During her tenure, the fund has grown from $14 million in assets to nearly $6 billion. It has a five-star rating from Morningstar, and it consistently ranks among the top funds in its category for performance. It’s also beat back risk well, enjoying an upside capture rate of 111.49% over the last five years while boasting a downside capture rate of 72.8%.
Some of the 50 or so stocks in the mid-cap fund are graduates from the small-cap product that have migrated over. Among the other mid-caps are stocks she followed for years as small caps, but didn’t feel comfortable buying until they became more established, mature companies. “We see this portfolio as a natural extension of Small Cap Focus, with an overlap that is very small. Right now, the overlap is less than 18%,” she says.
She believes there is an advantage in witnessing a company’s growth curve and seeing it withstand the test of time. “I think of it like having a child. My son is now 10 years old, so knowing him for these past 10 years provides me with a lot of insight into his development. And when he becomes a teenager, I think I’m definitely in a better position to understand him than if I’d never known him as a kid.”
She believes that mid-caps as an asset class are extremely attractive on a risk/reward basis because they have the growth potential of small caps, as well as higher quality attributes more akin to large-capitalization companies. “Small caps are in the first, second or maybe third inning of their development,” she says. “Mid-caps are in the fourth or fifth inning.”
Same Process, Different Stocks
Alger’s mid-cap product uses the same process that yielded the firm success in small caps—with some notable portfolio composition differences.
Both the small and mid-cap funds invest in growth companies that have a low debt-to-capital ratio and strong cash flow. Price-to-earnings ratios are less important to Zhang as an evaluation tool because she believes they are too easily manipulated and don’t convey a lot about a company’s true financial picture or prospects. Both Alger funds own about 50 stocks, and typically hold a security for three to five years.