After the downturn, Jones bulked up on mispriced growth stocks of strong companies that she felt had been punished too severely by the market and would eventually recover. “We’re looking out at what’s going to happen over the next three years, not the next six months,” she says.
Besides these stock combinations, Jones employs other strategies to smooth out returns and keep the fund less volatile. Each component sector may deviate no more than 10 percentage points from its weighting in the Russell 2500 Index, and no stock can account for more than 5% of equity assets.
The fund also spreads its bets widely over a swath of more than 100 stocks: The top 10 recently accounted for less than 20% of assets. Analysts set exit prices before purchasing a stock, though that target may be adjusted occasionally over time, and they look for a typical holding period of between two and three years. The biggest group of companies are those with $5 billion to $10 billion in market cap, which represented 46.6% of the fund’s assets as of June 30. Companies with a $2 billion to $5 billion market cap make up another 31.3%.
Right now, the fund has a higher than average allocation to steady eddies, a reflection of Jones’s concerns about market uncertainty. On the plus side, smaller-cap valuations are at or below long-term price/earnings averages, unlike those in the large-cap space. Usually, small caps sell at a premium. “The last time we saw this was 10 years ago,” she says. “That’s not to argue that the small-cap space is inexpensive, but it’s not as bad as it appears at first glance.”
She still sees pockets of opportunity for uncovering value. “This is a bifurcated market where certain areas, such as technology, have become quite expensive,” she says. “But others still have mispriced growth stocks that are selling at relatively attractive valuations.”
Some of these stocks can be found in the retail sector, where what she calls “the great Amazon pall” is casting a shadow over some strong companies that will thrive despite the market giant’s increasing dominance. She cites as an example a global apparel manufacturer (whose name she won’t mention because the fund is actively trading the stock), as an undeserved victim of the Amazon threat. She believes the apparel company has better prospects than many people think because it serves both the online and bricks-and-mortar retail establishments.
Earlier this year, the fund invested in companies that provide services to the housing market—from roofing, heating and air conditioning to softer services such as pest control and financing. Despite the Fed’s interest rate hikes, the ongoing demand for housing remains strong, and Jones believes the nascent but meaningful wage growth by millennials, now the largest generation in the U.S., could help the market expand.
Today, small and mid-cap stocks have a yin-yang group of forces working for and against them. On a positive note, optimism among small business owners has been high since President Trump won the U.S. election, according to a survey by a leading small business administration. Because the largest companies already have ample ways to lower their taxes, the president’s signature campaign promise of lower corporate tax rates would be particularly welcome by small and mid-sized companies.
