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| | Mutual Funds
A fund for the long-term worrywart
Aegis Value Fund has done well when the market struggles by holding onto cash. But will its growing asset size hurt its performance?
By Timothy Middleton
The last time Aegis Value Fund (AVALX) was sitting on the kind of cash hoard it has now, the market melted down more than 20%.
The average small-cap stock has gone up 70% to 80% over the last 15 to 18 months, says lead manager Scott Barbee, whose cash level is 53%. The list of companies that meet his strict valuation criteria has shrunk to 110 names from 450 less than two years ago.
If you're worried about a market decline, and some of the best minds in investing are, Aegis is your kind of fund. Since I first profiled it three years ago (see How some funds dodge a bear-market bullet), it has defied every challenge the market threw in its path, beating the S&P 500 ($INX) index by an average of nearly 14 percentage points annually.
These guys are extraordinarily strict, Benjamin Graham-type value investors, says Steven Rog, research analyst for R.W. Rog & Co. in Bohemia, N.Y. We feel theyre going to do very well, especially for the conservative investor who wants to dabble in the micro-cap area.
But Barbee isnt expecting double-digit gains now. After surging 35.8% last year, the fund is ahead only 5.4% this year, as of Sept. 16. While thats more than twice the markets return, it is worse than about 70% of other small-cap value funds in the Morningstar database.
Sitting on cash
Its lagging because more than half its $715 million in assets are sitting in cash. That's very un-fund-like behavior. The usual level is 5% or less.
Aegis Value is an unusual fund in other ways, as well. If you are a pigeon-hole investor, slotting your funds into index-based categories like micro-cap, this fund isn't for you.
And it is not for performance-chasers, although it has plenty of them as shareholders. Since my earlier column, the funds assets have increased tenfold. If the market falls as Barbee expects, they're likely to be disappointed.
But if your investment horizon is longer, say five years or more, you might be very pleased with Aegis even if stocks swoon. The last time they did, the fund made a profit. That was the tumultuous latter half of 2002, leading up to and culminating in the invasion of Iraq.
In the spring of that year, Barbees assets quadrupled, after a stunning gain the prior year of 42.7%. The funds cash reserve crested at 62% of assets, and the managers timing was superb. The market began a decline that took the S&P 500 index down 22.1% by year-end. Aegis bought furiously amid the rout, drawing down cash to 13% and finishing the year ahead, albeit by a slender 1.4%.
Were interested in putting our money into the market in the same manner during corrections in the future, Barbee says.
Following Buffett's mentor
Benjamin Graham was the mentor of Warren Buffett and the granddaddy of the school of investing that says cheap stocks will inevitably deliver greater returns than expensive ones. Barbee is another disciple. He's loath to pay more than about eight times earnings for a stock -- the market average is 26 -- and he never pays more than book value, or the net asset value of a company. The market happily pays nearly five times book.
Barbee also limits his universe of stocks to small-cap issues, those with capitalizations of $1 billion or less. And of the 110 companies that currently meet all of his criteria, some are cheap because theyre bad. Aegis owns only about 60 names, and about half of all the funds invested assets are concentrated in 10 of them.
We currently have a lot of assets in tobacco-leaf dealers, Barbee says, including Standard Commercial (STW, news, msgs) and Dimon (DMN, news, msgs). Both stocks are down about 20% in the last year, hurt in part by lawsuits against their customers, cigarette makers.
But the leaf dealers aren't parties to those suits, and their marketplace could be liberated if a proposal in Congress to eliminate quotas on tobacco production is adopted. Barbee thinks that is likely. The dealers would benefit from greater capacity utilization.
The leaf dealers have market caps in the range of $200 million to $250 million, small but not quite micro. Three years ago, when his assets were $71.5 million, Barbees average market cap was $160 million. Now its more than $300 million.
Costs of success
This is an inevitable consequence of the funds enormous growth, and it worries nearly everybody except Barbee. Rog, whose clients are shareholders in the fund, has been lobbying for Aegis to close to new investors.
The most recent Morningstar report on the fund, by analyst Greg Carlson, begins, Unchecked asset growth has turned Aegis Value into a less attractive, but still worthy, offering.
As Ive noted in prior columns, many of the best small-cap funds are closed, but Barbee revels in the lush fees more assets produce. The funds expense ratio is 1.5% and hasn't come down as assets have grown.
We are not doing this as a charity, Barbee says. Were in this to make a buck. He also says the growth in assets has created dis-economies of scale, forcing him to hire additional analysts and other staff.
We are interested in driving a good return to shareholders, and if were unable to do that, we will close the fund, he says. But the idea that somehow we should be giving a discount to shareholders, we dont find that to be something that we as advisers think.
A take-it-or-leave-it approach
You have to respect his candor. Even the employees of the Salvation Army work for a paycheck, although I expect a smaller one than Barbee takes home.
So this is a take-it-or-leave-it fund. Its short on cuddle and fund orthodoxy but long on returns. In approach its about as far away from indexing as you can get, and I disdain closet index funds, as I explained in a column two months ago.
And for what its worth, the funds naysayers have been wrong in the past, including me. I commented in my 2001 column that it was already getting too big to remain a top performer. I was clearly wrong.
Taking profits
Aegis sells stocks it considers overvalued, and lately its been taking profits in OMI (OMM, news, msgs), which operates a fleet of oil tankers. The stock has doubled in the last year as the price of crude has soared. Everybody is saying this is going to continue forever, and it isnt, Barbee says. Getting into the stock when it was trading below book and selling now that its priced at 170% of book is, he says, a classical cyclical play.
And another: Aegis also is dumping Atwood Oceanics (ATW, news, msgs), an offshore oil and gas driller. The fund bought the stock 18 months ago, anticipating higher oil prices. Now that theyre here and the stock is up 85%, the price is far above book value.
At the time of publication, Timothy Middleton didnt own any securities mentioned in this article.
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