These funds rode small companies to big returns

  • By Tim Gray,
  • The New York Times News Service
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Three of the first quarter’s top-performing mutual funds won big by favoring small- and midcap growth stocks, toting up quarterly returns of 25 percent or more.

The Virtus Zevenbergen Innovative Growth Stock Fund (SAGAX) buys shares of companies of all sizes — its largest holding lately has been Amazon (AMZN) — but its big winners, so far this year, have been smaller fare such as WayFair (W), an online seller of home furnishings, and the Trade Desk, an online advertising marketplace.

Nancy A. Zevenbergen, the fund’s lead manager, said her interest in growth stocks dates to the ’80s. She worked then in the trust department of a Seattle bank and followed — and was fascinated by — the 1986 initial public stock sale of a homegrown outfit named Microsoft (MSFT). (Microsoft is based in the Seattle suburb of Redmond, Wash.) A year later, she started Zevenbergen Capital Investments in Seattle. Her mutual fund began in 2004.

Being on the West Coast has proved an advantage, she said. Not only has Seattle birthed tech giants like Microsoft and Amazon, but “Silicon Valley is a day trip for us,” she said.

Throughout her career, she has sought stocks she thinks can keep increasing revenue by at least 15 percent a year. Her mantra is: “Revenue growth, revenue growth, revenue growth,” she said.

Favorite holdings can stay in the fund for years: Mercadolibre (MELI), an Argentine e-commerce outfit, has been there for a decade. That stock was lately one of only 31 in the fund, compared with 157 for the average actively managed United States stock fund tracked by Morningstar.

Ms. Zevenbergen says she prefers companies that are run by their founders. As an example, she pointed to Microsoft. The stock soared while one of the founders, Bill Gates, steered the company but languished under his successor, Steven A. Ballmer. What’s more, boards of directors are typically not as patient with outsider C.E.O.s, and long-term investments require patience, she said.

Her liking for founder-led outfits is part of the reason her fund has owned Tesla (TSLA), the electric-car maker led by Elon Musk, since its 2010 initial public stock offering. Despite Tesla’s recent operational problems, she said: “Elon Musk is doing things people said couldn’t be done — and he’s up against an old, established industry and organized labor.”

Ms. Zevenbergen added: “You can often get a C.E.O. with an M.B.A. from Harvard, but do they have the passion to run the business that the founder had?”

The Virtus Zevenbergen fund (SAGAX), whose A shares have a net expense ratio of 1.25 percent, returned 25.24 percent in the first quarter, compared with a total return of 13.65 percent for the S&P 500 stock index (.SPX).

Alger SMid Cap Focus Fund (ALMAX)

Matthew A. Weatherbie, one of the managers of the Alger SMid Cap Focus Fund (ALMAX), has been chasing growth stocks even longer than Ms. Zevenbergen. His investment career began in the ’70s, and he ran Putnam Voyager, then a well-known fund, starting in 1983. He left Putnam to start his own investment company in 1995, and he has managed the Alger fund since 2017. (Alger Associates acquired Mr. Weatherbie’s company in 2017.)

Like Ms. Zevenbergen, he said his investment philosophy has remained consistent. “There have been some tweaks over time, but the basic process is the same,” he said. He and his co-managers seek companies in a growth sweet spot, he said. “They’ve been in business long enough to survive the perils of infancy, but they’ve got a long runway of growth ahead of them.”

Holdings also must have “a competitive moat around the business, a strong balance sheet, high inherent profitability and a high-quality management team,” he said.

To assemble the portfolio, the fund’s managers and analysts collaborate to identify 50 holdings that meet these criteria. Mr. Weatherbie and his co-portfolio managers — H. George Dai and Joshua D. Bennett — next take an unusual step.

They divide the portfolio into three baskets. The managers then independently evaluate the 50 stocks, each determining the portion of the fund’s assets dedicated to each stock in his basket. As a result, the fund’s largest stakes are the stocks most favored by all three.

“Why is Chegg (CHGG) or FirstService (FSV) a top five holding?” Mr. Weatherbie asked. “Because each of us has determined that those are high-conviction names.”

Chegg is an education-services company, while FirstService is a property manager and service provider for condos and cooperatives.

Mr. Bennett said both companies exemplify something the managers hunt for: They’re fast growers in “mundane markets” not associated with zippy stocks in the way, say, consumer electronics and online entertainment are. Mr. Weatherbie added: “Our process enables us to identify hidden gems in mundane industries.”

The Alger fund, whose A shares have an expense ratio of 1.33 percent, returned 30.58 percent in the first quarter.

Lord Abbett Developing Growth Fund (LAGWX)

F. Thomas O’Halloran, the lead manager of the Lord Abbett Developing Growth Fund (LAGWX), seeks companies that show both disruption and momentum. For example, he has won lately with such well-known names as Yeti Holdings, the maker of insulated cups and coolers, and Roku, the video streaming outfit.

These companies are disrupting their industries, he says, and their shares have lately trended upward.

Take Roku and its streaming devices, which compete with ones sold by such tech behemoths as Apple (AAPL) and Amazon. “It’s not that one form of streaming is better than another,” Mr. O’Halloran said. “It’s that streaming is better than cable and regular TV, and Roku is the only Swiss-neutral platform.” Other devices are interwoven with technologies or business models peddled by their sellers.

Mr. O’Halloran said he often finds promising picks among consumer stocks for the simple reason that consumer purchases drive growth in the United States. “That’s where 70 percent of spending in U.S. economy is,” he said.

When considering what to wager on, Mr. O’Halloran said, he prefers companies with hefty potential markets — like Yeti. “The whole planet likes its food and beverages at the right temperature,” he said.

He differs from some portfolio managers in that he bars members of his analyst team from writing reports on the companies they follow, relying instead on quick emails and frequent meetings. Churning out reports can lead to delays and self-defeating behavior, he said. “By the time you get a report done, a quarter to half of the stock move may be over. And when the stock peaks, you don’t want to let it go, because you wrote the big report on it.”

Mr. O’Halloran’s fund, whose A shares have an expense ratio of 0.93 percent, returned 27.13 percent in the first quarter.

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