For small-caps, negative sentiment a big positive: Schachter

If the overall market doesn’t like a particular small-cap stock, there’s a good chance portfolio manager Joshua Schachter is already running the numbers to determine the upside of getting in now.
“When there is analysts’ coverage on a company, we prefer negative sentiment,” said Mr. Schachter, who manages the Snow Capital Small Cap Value Fund Ticker:(SNWAX) at Snow Capital Management, which manages $3 billion in assets.
“We want to buy when something is out of favor,” he said. “Behavioral finance is a large piece of the puzzle, and our value-add is figuring out what will change market expectations.”
The fund was launched in November 2010, but Mr. Schachter has been managing the strategy as a separately managed account for the past six years.
The portfolio of between 40 and 60 stocks is constructed by identifying changes in investor sentiment, which often shows up in the form of price-to-earnings-ratio contraction.
“We describe our basic strategy as contrarian relative value,” Mr. Schachter said.
Because he is buying stocks that often are shunned by the market for various reasons, Mr. Schachter said he is benefiting from an “asymmetrical risk-reward” scenario.
“We calculate target prices for our stocks and we want a four-to-one ratio of 100% upside compared to 25% downside,” he said. “The minimum we want when we buy a stock is 50% upside.”
The fund’s target market includes companies with market capitalizations of between $100 million and $3 billion, offering plenty of room to invest, Mr. Schachter said.
“We’re seeing lots of value today, but there are always parts of the market that people will hate,” he said. “Plus, small-caps are generally inefficient and there’s not a lot of sell-side analyst coverage.”
Two of the larger themes that have developed in the portfolio involve the health care and industrial sectors.
“There is still a lot of uncertainty surrounding health care reform,” Mr. Schachter said. “For that reason, we’re seeing P/E ratios in the 6-to-8 range with companies that are trading below book value and with lots of free cash flow.”
Some examples in the health care space include Health Net Inc. Ticker:(HNT), Kindred Healthcare Inc. Ticker:(KND), and Community Health Systems Inc. Ticker:(CYH).
Opportunities in the industrial space center largely on the global expansion in infrastructure, which Mr. Schachter said will include $2 trillion in spending over the five years.
Industrial sector examples include Spirit Aerosystems Holdings Inc. Ticker:(SPR) and Terex Corp. Ticker:(TEX).
“Global infrastructure will be a pretty attractive story for years to come,” he said.
So far, this year, the fund is up 15%, while the small-cap value category is up 11.2%, and the S&P is up 7.6%.
Portfolio Manager Perspectives are regular interviews with some of the most respected and influential fund managers in the investment industry. For more information, please visit InvestmentNews.com/pmperspectives.