It’s one thing for a mutual fund to outperform the market in a year when everything seemed to tank, but it’s another for that fund to outshine its peers on 3-, 5- and 10-year basis. David Sissman, co-portfolio manager and managing director of research at Private Capital Management, made small cap stocks his specialty and takes a long-term focus as an investor. “The nice thing about being in the public markets is that business analysis on publicly traded companies is available 24/7, and there are lots and lots and lots of companies to look at,” he said. That approach aligns with the firm’s Private Capital Management Value Fund (VFPIX), which focuses on holding and deeply understanding a handful of small-cap companies. VFPIX declined 4.41% last year. However, the fund posted a total return of -1.17% in 2022, according to Morningstar, meaning it was able to mitigate some of the losses felt by both small caps and the broader market. Meanwhile, the broader S & P 500 lost 19.4% in 2022, while the small-cap focused Russell 2000 dropped about 21.6%, according to FactSet. VFPIX .RUT,.SPX 1Y mountain Comparison chart Morningstar rates the fund, which has a net expense ratio of 1.2%, five stars and in the top percentile for 2022. It’s also in the top percentile for one-, three- and five-year trailing returns. With respect to 10-year trailing returns, the fund has a trailing total return of 11.49%, as of Jan. 20, compared to the 9.16% trailing total return for peer funds in its category, Morningstar found. The firm’s initial client was the Collier family, a major landowner in Florida. In the same vein, the employees of Collier Enterprises, a real estate investment firm, were among the early investors at Private Capital Management through their retirement plan and were part of the reason the fund was first created. About one-third of the fund’s assets today are from the retirement plan assets of Private Capital Management employees. The ‘holy grail’ Sissman said his team looks for small-cap stocks with an “X-factor,” a term he uses to describe companies that not only have significant cash flows, but also have some type of innovation or project in the works that could help transform the company over time. “That’s really our holy grail,” Sissman said. “We can justify the valuation based on the current business. But within three or five years, the business is going to change to something else that’s bigger and better — or if it’s not bigger, at least has better margins.” Sissman pointed to online marketing company QuinStreet as an example of this strategy. He noted how the company went “through the desert” as it dealt with changes to the for-profit education space, one of the three sectors the company focused on, but came out stronger. And Sissman said QuinStreet faced a test as increasing costs in the auto industry hurt marketing in the sector in 2022. But he said 2022’s auto headwinds would likely turn into tailwinds this year for the stock. “You can start to see where they’re coming out of the desert,” he said of challenged stocks. “That’s when we can act more aggressively in position sizes. And that’s what really makes a difference in portfolio performance.” QuinStreet was the second biggest holding at just under 8% at the end of 2022. The 10 biggest holdings — led by Target Hospitality at 11.3% — accounted for just over 50% of the fund. It had 32 holdings as of the end of 22, with 78.6% of them having a market cap under $2 billion. Target Hospitality, which provides workforce lodging and temporary housing for oil, gas and mining operations and government agencies, soared more than 300% in 2022. Risk and reward Morningstar notes the fund has “a strong management team and sound investment process,” though said its fees are a hurdle — priced in the second-highest quintile among peers — and has an overweight tilt toward risk. Sissman said the fund disagrees with the assessment of a focus on risk, saying it thinks about risk as less related to standard deviation on returns and more about how a decision would permanently impact capital. Though fund leadership understands small-caps can trade with more variability, they don’t equate that with exposure to more risk. Holding that relatively small number for an average of six years comes with advantages, he said, especially in a stock-picker’s market. He said there are more companies to choose from, with many stocks’ market caps slashed into small-cap territory in 2022’s bear market. “If you start looking at a stock and you say to yourself, ‘There are too many variables that I’m never going to be able to understand in order to make this a meaningful position,’ it’s not worth the journey, right?” he said. “We’re better off taking our finite time and spending it on something where the probabilities are higher that we’re going to get a favorable outcome.” That strategy has helped in 2022 and long before, he said. The fund was able to outperform the broader market last year despite not holding shares of energy companies, which was the sole S & P 500 sector to gain share value last year. He’s watching how headwinds turn to tailwinds for stocks this year and trying to position himself to benefit from those changes. But he said the overall focus on knowing a company well and finding that hidden X-factor hasn’t changed with the new year. “Our process is still going to be based on the bottom’s-up, and the opportunities we can see,” Sissman said. “It’s on us to marry those companies that we’re investing in [and] the appropriate sizes with the macro environment that exists at the time.”
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