Scruggs’ fund does well when investors are flat-out spooked

For some bottom-up stock pickers, the recent market volatility has been akin to an investment sweet spot, according to Steve Scruggs, manager of the Queens Road Small Cap Value Fund Ticker:(QRSVX).
“We find that when the markets are pricing reasonably, we tend to hang around, and we usually lag when the markets are really taking off,” he said. “But when we really do well is when [investor] fear takes over.”
The fundamental analysis has resulted in a large allocation to technology sector stocks, with a particular emphasis on the semiconductor space, Mr. Scruggs said.
“This is not part of a call on the tech sector; it’s the result of looking at everything that’s out there,” he said. “We’re just seeing a lot of value in tech right now.”
Another sector that has emerged for this fund — which limits its investments to companies with market capitalizations under $2 billion — is the utilities space.
“Looking at the operating margins, I like utilities relative to what else is out there,” he said.
One example is South Jersey Industries Inc. Ticker:(SJI), which Mr. Scruggs described as a conservative investment with a 2% dividend yield.
While the fund is not a defensive strategy, it does have the flexibility to try to avoid major potholes by building cash positions if necessary, Mr. Scruggs said.
Along those lines, he said, the fund has been adding to the cash balance since late last year and currently has about 21% in cash.
“That is a high cash balance for us,” he noted, “but it’s a call on where we see valuations.”
The fund held a 15% average cash balance through most of 2008, and the fund was fully invested starting in early 2009 when the market bottomed out.
“Right now, we’re waiting to identify some individual investments that meet our criteria,” he said. “We have a long watch list of companies we like, but they’re just too expensive.”
The portfolio, which comprises about 60 stocks, has an average annual turnover rate of 30%, suggesting a substantial commitment to the underlying investments.
The four-stage stock-picking process begins with the hard data related to factors such as balance sheet strength and serviceable-debt levels. From there, Mr. Scruggs will focus on valuations, management and finally the industry and sector.
“Our research goes from the most concrete, or fact-based, to the most subjective, or opinion-based,” he said.
One of the positions Mr. Scruggs has been building is RadioShack Corp. Ticker:(RSH).
“Over the last three or four years, RadioShack has really transformed away from being a dusty old seller of electronics to hobbyists,” he said. “The company is still in the middle of its transformation, but it has a very strong balance sheet, even with some debt.”
Last year, the fund gained more than 21%, which compares with a 26% gain by the small-cap-value category, as tracked by Morningstar Inc., thus ranking the fund in the 87th percentile.
But over the past month, the fund’s downside protection has limited losses to 4.5%, which compares with a 6.2% category average loss, ranking the fund in the third percentile.
It was a similar story in 2008, when the fund fell by 23.8%, compared with a category average decline of 32.2%, ranking the fund in the third percentile that year.

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