A Great Way To Diversify Exposure To Small Cap Stocks

July 30, 2011By: Ian WyattArticles RSS feedPrintPrint

The Buffalo Small Cap (BUFSX) mutual fund was one of the earliest purchases in my $100k Portfolio, with an initial position bought in April 2009. This was followed by another purchase in October 2009. I sold the fund in early April for a healthy 43 percent.

The long-term performance of this fund was outstanding, with an average annual return of nearly 11 percent putting this fund in the top five percent of small cap growth mutual funds over the last decade. However, the track record in recent years has lagged its peers. Since the March 2009 lows for the stock market, Buffalo has risen 110 percent - but that gain has lagged the 140 percent gain for the benchmark Russell 2000 index.

As mutual funds grow, it becomes more difficult for the fund managers to find attractive investments to make, since the size and number of those investments must increase with more capital under management. Funds with great track records often run into this problem, particularly funds that invest in very small companies, such as Buffalo.

For this reason, Buffalo Small Cap closed its doors to new investors.

Several months ago I sold my shares of Buffalo Small Cap, and replaced the fund with another small cap fund that I think will perform well over the coming months.

The fund I selected is Cambiar Small Cap Fund (CAMSX) of Denver, and is managed by employee-owned Cambiar Investors, an investment firm with nearly $6 billion in assets.

Cambiar's managers take a value-oriented investment approach, aiming to buy companies that are trading at the low end of their historic valuation range. But buying inexpensive stocks alone isn't exactly a recipe for success.

The managers also look to buy stocks that are misunderstood and have the potential to exceed expectations due to future catalysts such as new products or management changes that may result in strong financial results over the next one or two years. The fund prospectus says, "The result is a portfolio of high-potential, low expectation companies that we believe should be able to outperform regardless of the current investment climate."

This fund is small, with just $655 million in assets under management, well below the $3.2 billion at Buffalo Small Cap. When investing in small cap funds, a smaller asset base is often better to allow for more nimble asset management.

Cambiar typically holds anywhere between 45 and 55 stocks, and weights each position roughly equally at two percent of assets. The average market cap of its holdings at $2.2 billion means that this fund is a small cap fund that also invests in companies that I would consider mid-caps - those with market capitalizations of above $2 billion.

The average forward PE ratio of its holdings is just under 13, a deep discount to the PE of 20 for the Russell 2000 and PE of 18 for the Russell 2000 Value index. The fund's favorite sectors today are Industrials, Technology, and Financials.

The performance of the Cambiar Small Cap Fund has been outstanding, with gains of 180 percent since the March 2009 lows. Over the last five years, the average annual return has been 7.1 percent, which is a full 4.5 percent ahead of the S&P 500 and places this fund in the top nine-percent among small cap blended (growth and value) mutual funds.


Small cap stocks have been leaders in the last two years, gaining 82 percent versus 54 percent for the Dow Jones Industrial Average. After such a strong recovery for stocks in general, and small caps in particular, I've been transitioning the $100k Portfolio to more value-oriented investments.

This includes our transition from a small cap growth fund (Buffalo) and into a value fund (Cambiar).

I don't expect we'll experience 32 percent gains for Cambiar in the coming year, which is what investors experienced in the last 12 months.

However, I do believe that the performance of this fund will continue to outperform the small cap benchmark in the coming years. For investors looking for diversified exposure to small cap stocks, the Cambiar Small Cap Fund is a great choice.

Ian Wyatt
Chief Investment Strategist, Wyatt Investment Research
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