An honourable mention in Smart Money as long as being selected as BUY now because it was a big loser last year being honourable.
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January 29, 2001
SMARTMONEY.COM: Big Returns From Tiny
Companies
By ELIZABETH HARRIS
(This report was originally published late Friday.)
NEW YORK -- Robert Kern is as intent on finding losers as he is on finding winners.
He has to be when he's sorting through the challenging universe of microcap stocks -
5,000 equities that represent the smallest of small companies. Most investors don't focus
as much as he does on identifying likely dogs, he believes. 'But a key reason for doing
research is to minimize the investment mistakes,' Kern says. 'Performance is really the
net of your winners minus your losers.'
Over the course of his tenure as a microcap investor, Kern has clearly managed to
sidestep plenty of pooches. As manager of the $750 million Fremont U.S. Micro-Cap
fund (FUSMX), he has racked up a 29% five-year annualized return, and so far this
year, the fund is ahead 9.86%, according to Morningstar. Last year was a rare bummer:
The tech-heavy fund lost 10.6%. Of course, that same tech focus helped in 1999, when
the portfolio gained a stunning 129.5%. 'I wish I could have saved a little to offset the
negative number in 2000,' Kern says. 'But all things considered the decline was fairly
modest.'
In fact, Kern has little to regret about his nearly 20 years of microcap investing. In 1982,
he first zeroed in on the group, which he currently identifies as companies with market
caps ranging from $10 million to $750 million. (His technical definition of 'microcap' is
the bottom 5% of all equities ranked by market cap.) Back in 1982, he was one of a
handful of investors willing to divide the smallcap universe into even smaller bits. Not
that he was trying to be a pioneer. Rather, Kern signed on to manage a private
profit-sharing account with a mandate to invest in companies at the venture-capital
stage. That plan failed, since calculating accurate values frequently enough to satisfy his
employer's reporting requirements proved too difficult. At that point, Kern's bosses
'posed the question, 'Are there small-cap companies that might have venture-capital
characteristics?" he recalls. So his microcap career was launched.
Kern was successful enough in that endeavor to inspire Fremont Investment Advisors to
enlist him to launch and manage a microcap fund in 1994. Since then, his nimble
stock-picking has drawn a crowd. Last March, Fremont closed the fund to new
investors after its assets grew to $1 billion - a large sum to manage when investing in
small-cap, let alone microcap equities. But last week, the fund again began accepting
new investments, spurred, Kern says, by his feeling that the market now offers some
significant opportunities.
In general, Kern tries to spot sectors where 'innovation is occurring at its highest level.'
These days, he says, those areas include technology, health care, consumer goods and
services. Kern then wades into each category, studying the companies at a fundamental
level, looking for growth and strong management. The wide tech sell-off has prompted
him to devote extra energy to that sector. If technology is off 50% on an unweighted
basis, he reasons, 'that means many companies are off by more than that.' So Kern, who
lightened up on his tech weighting last year, so that it represented 28% at year end, is
ready to dive back in.
But he's still highly selective. With the new money he expects will come into the
reopened fund, Kern says, he plans both to add to current positions and to buy new
stocks, which could inflate the fund's total holdings from 81 companies to as many as
100. While he's optimistic about the tech sector as a whole, he is particularly upbeat
about optical and semiconductor companies. At the moment, he's eying Axsys
Technologies (AXYS), which he says is one of the few companies focused on automatic
manufacturing and assembly of optical components. He also likes PRI Automation
(PRIA), which is involved in automating semiconductor factories. While PRI lost
investor support because of difficulties in ramping up manufacturing facilities, Kern
believes the sell-off - from around $90 to $20 a share - was too punitive.
Kern is also enthusiastic about his largest holding, Boston Communications Group
(BCGI), which he has owned for several years. The company is involved in prepaid
wireless service, which, he notes, has not taken off in the U.S. as it has in Europe. But
'certainly there is a niche for prepaid,' he says. Kern not only expects overall growth, but
he also anticipates other carriers to continue to farm out that area to specialists like
Boston Communications.
While he expects the portfolio's assets to grow, Kern says, it doesn't automatically
follow that the fund will close again. Mindful of the need to prevent it from becoming
unwieldy, he is also confident that his firm, Kern Capital Management, can continue to
highlight promising microcap stocks. He notes that few other investment-management
companies have developed the same expertise. 'There isn't a lack of opportunity,' Kern
says. 'It's a question of, 'How much, in terms of research, are you willing to commit to
finding those opportunities?"
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