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| | Mutual Funds
Fund finds cool returns in un-cool places
Keeley Small Cap Value avoids tech and rifles the sale rack instead, where a leaner, meaner industrial America is enjoying outsize gains as the economy strengthens.
By Timothy Middleton
In this summers turbulent market, shares in companies that make things have been holding up, while hot concepts have been turning into hot air. Thats one reason Keeley Small Cap Value Fund (KSCVX) has been pummeling the market.
With more than half of its $144 million in assets in industrial materials and other sectors of the manufacturing economy, this undiscovered fund has spurted 9.7% this year through July 6. In contrast, the Vanguard 500 Index (VFINX) struggled to advance 1.2%.
Youve had a reawakening of the heartland of America, says manager John Keeley, who has piloted the Chicago-based portfolio over the last 10 years into the top 10% of small-cap funds, as measured by Morningstar. These industrial-type companies were asleep for five years, with management cutting (costs) to stay afloat, and now theyve gotten a whiff of business.
Keeley Small Cap Value has nearly everything I look for in a mutual fund: consistent performance, immunity to investment fads, heavy insider ownership, an independent board and declining fees.
Like another fund I profiled recently, Cullen Value (CVFCX), it was started by a boutique management firm for the family and friends of its private clients, who invest a minimum of $1 million with the firm. It has more than $1 billion of such assets outside the mutual fund, representing institutions and wealthy individuals.
Tech? Forget it
The raps against the fund are two: First, it eschews tech completely, including medical technology, meaning it is condemned to underperform when those sectors shine. Secondly, it has a front-end load, or sales commission, of 4.5%. The commission is low by brokerage standards, but punishing for self-directed investors.
By the same token, ruling out load funds means ruling out some of the best in the business. Many small-cap funds are closed to new investors. Solid performer FPA Capital (FPPTX), also a load fund, closed just this month. So Keeley Small Cap Value merits an especially close look.
We like what this fund brings to the table, analyst Shannon Zimmerman wrote in a recent Morningstar analysis. Keeley is a bit of a contrarian.
Specifically, Keeley focuses on companies the rest of Wall Street habitually ignores: newly public companies such as spin-offs and savings and loan conversions; companies trading below book value and turnarounds. Buying what others are not allows us to get in early in a companys life cycle, he says.
Not necessarily early in a companys life, however. The fund owns shares in Levitt (LEV, news, msgs), a homebuilder that made its name constructing tract houses in the Northeast after World War II. Years later Levitt was acquired by BankAtlantic Bancorp (BBX, news, msgs). The bank didnt have the funds to support the builders growth in Florida, however, so BankAtlantic spun it off to shareholders.
A bargain
When it came out, nobody had done any research on its intrinsic value, Keeley says. We spent the month prior to that happening trying to figure out what theyre worth. It set that value at $21 a share and built a stake at $14. The shares trade now at $24, but Keeley believes intrinsic value has risen closer to $33.
Keeleys approach is to own roughly 100 names in his portfolio, with 1% of assets allocated to each. No position is allowed to grow to more than roughly 2%; such positions are trimmed back with the proceeds invested in other names
| Keeley Small Cap Value's top holdings | | Security | Industry | | Harvest Natural Resources (HNR, news, msgs) | Energy | | Quicksilver Resources (KWK, news, msgs) | Energy | | EnPro Industries (NPO, news, msgs) | Industrial materials | | Reliant Energy (RRI, news, msgs) | Energy | | Choice Hotels (CHH, news, msgs) | Consumer services |
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Source: Keeley Small Cap Value Fund
The funds biggest sector stake, as is common with value funds, is in financial stocks, which account for 28% of assets. But its performance juice currently is coming from energy and industrial stocks, at 17% and 10%, respectively, of assets.
Thats been our emphasis for the last year or so, Keeley says. Ive got a higher degree of conviction about the 17% and the 10% than I do the 28%, because of the strengthening economy.
Keeley Small Cap Value sailed through the bear market almost unscathed, beating the S&P 500 ($INX) by 13 percentage points a year in each of the last three, as of May 31. It did very poorly in 1998 and 1999, however, eking out marginal returns each year because of the aversion to technology.
We are not involved in tech or medical (because they have) a short (product) lifecycle, he says. Keeley invests with a time horizon of three to five years; turnover in the fund, 39%, is only two-fifths the average for domestic equity mutual funds.
Eating his own cooking
Five of the six directors of the Keeley fund are outsiders; Keeley himself is the only insider. The Keeley family is the funds largest shareholder, accounting for 10% of assets. Though the fund is small, its expense ratio has declined, 1.61% this year from 1.75% last year. That's slightly above the category average, but Keeley says it will continue to decline as the cost is spread over more assets. As recently as two years ago, the funds assets were less than $75 million.
Keeleys son, Mark, who does the funds marketing, defends its front-end load as fair compensation for brokers who recommend it and a deterrent to rapid traders, who can take profits from long-term investors. We dont want to be the flavor of the month, he says. That hurts everybody whos in here, including ourselves.
Mark Keeley also says much of the net inflow into the fund comes without the load, through 401(k) plans, most of them run by small Midwestern companies. More than half the funds shareholders own accounts worth less than $10,000, he says.
Small investors are often disappointed that no-load fund companies shun their business; the initial minimum at most Vanguard funds is $3,000, or $1,000 in an IRA. At Keeley, the minimum is $1,000 for a taxable account and $250 for an IRA.
Keeley Small Cap embodies values everybody likes to embrace: prudent management and long-term goals. Its just not the kind of fund that gets talked about at parties, unless the guests are trust officers and accountants.
What he's buying
All aboard: One of Keeleys favorite stocks is Providence & Worcester Railroad (PWX, news, msgs), a mini-capitalization rail operator in New England whose share price, currently $11, is nearly a third less than Keeleys $15 estimate of book value. This company has land on its books going back 150 years, the manager says. We think management eventually will sell the company, probably to another railroad.
A conversion play: The fund recently took a stake in NewAlliance Bancshares (NABC, news, msgs), a Connecticut thrift that converted to stock from mutual ownership at $10 a share. The funds stake cost $14 a share; Keeley thinks the shares are worth $18. It takes the market about three years to fully value such new companies, he says.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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