Reopening of small-cap funds draws financial adviser interest

A large number of small-cap funds have reopened in recent months and are drawing the attention of financial advisers.

While advisers remain cautious, many say that the funds could represent good investment opportunities for their clients. And some advisers are moving to invest in the funds right away, as they think the funds might not stay open long.

“It’s a pretty good opportunity to get into the small-cap arena,” said Joseph Alexopolous, principal of Aequitas Wealth Management LLC of Los Angeles, which manages $16 million in assets.

Of the 40 funds that have reopened since Jan. 16, 40% are small-cap funds, according to Morningstar Inc. The Chicago-based research firm categorizes micro-cap funds as a subset of small-cap funds.

The funds have reopened as market depreciation and redemptions have made room for managers to take in more cash.

“The market has been volatile, and investors start to leave funds when they get a little skittish,” said Bridget Hughes, senior fund analyst at Morningstar.

“Part of the reason to reopen is to stem those redemptions,” she said. “The market has been hard hit, which makes stocks more attractive from a valuations perspective.”

Morningstar fund analyst Marta Norton said she wouldn’t be surprised to see more small-cap funds reopen.

A decline in assets and expanded opportunities led to the May 19 reopening of the Third Avenue Small-Cap Value Fund (TASCX), said portfolio manager Curtis Jensen of Third Avenue Management LLC of New York.

The fund had $2.3 billion in assets when it closed in March 2006, but that had fallen to $1.9 billion as of last Wednesday.

“We closed as a result of the cash position, which had built up substantially to the point where we felt the pace of inflows was starting to outrun our ability to generate ideas,” Mr. Jensen said. “Today, we are seeing opportunities among our existing holdings as well as finding new things to buy.”

“A good fund will close when they don’t have opportunities to deploy new capital,” Mr. Alexopolous said. “It shows greater integrity to shareholders and fiduciary responsibility.”

Third Avenue’s decision to close the Third Avenue Small-Cap Fund was tied more closely to the rate of inflows than total assets. To avoid hot money, the fund introduced a $10,000 minimum and a redemption fee for investors who hold the fund for less than a year.

For the $4 billion Allianz NFJ Small Cap Value Fund (PCVAX), which reopened May 1, the determining factor in reopening was liquidity, not assets, said Kristina Hooper, head of the equity product management group at Allianz Global Investors Distributors LLC of New York.

“We are seeing dollar trading volumes today [that are] three times what they were when this fund was closed,” she said. “There is more activity in that space, more owners of shares, and it’s easier to move in and out.”

When the fund closed in October 2003, it contained $2.25 billion in assets. That had risen to $4.2 billion as of last Wednesday.

Several funds have reopened at Wasatch Advisors Inc. of Salt Lake City, including its flagship Small Cap Growth Fund (WAAEX), which closed in 2001 with $934 million in assets and reopened March 10 with $900 million in assets.

Many of the funds experienced redemptions as investors moved assets to large-cap funds, said Brian Bythrow, portfolio manager of Wasatch’s International Opportunities Fund (WAIOX) and the Micro Cap Value Fund (WAMVX), which also reopened in recent weeks.

“There are a lot of cheap stocks out there,” Mr. Bythrow said. “You want to buy them when they’re hitting their soft patch.”

As some favored small-cap funds have reopened, Carolyn McClanahan, founder of Life Planning Partners Inc. of Jacksonville, Fla., which manages $25 million in assets, has started to put her clients back in. “My hope is that the funds will continue to perform as they have,” she said.

Small-cap funds have enjoyed good performance over the long haul.

They posted a trailing year-to-date return of -3.08%, a one-year return of -10.94%, a three-year return of 7.73% and a five-year return of 14.24% through last Wednesday.

The Russell 2000 Index had a year-to-date trailing return of -4.63%, a one-year return of -11.66%, a three-year return of 7.34% and a five-year return of 13.43%.

Meanwhile, the Standard & Poor’s 500 stock index had a year-to-date trailing return of -4.52%, a one-year return of -6.99%, a three-year return of 7.38% and a five-year return of 10.55.

PROCEEDING WITH CAUTION

Still, some advisers are cautious.

“Investors need to find out if the manager has changed on the fund,” said Neil Elmouchi, president of Summit Financial Consultants Inc./LPL Financial of Westlake Village, Calif., which manages $150 million in assets.

“If the assets went down because the market went down, the universe of stocks they have to invest in may not have changed,” he said. “Just because they open their doors doesn’t mean you automatically get in.”

If the fund has the same manager with a good track record, investors may want to get a foot in the door.

“You could put in $1,000, and then you can add more to that later. The fund may close up again in six months or a year,” Mr. Elmouchi said.

Analysts agree that the window may not be open long.

“When you have a fund that has historically closed, it’s likely to close again. Most of the funds don’t give you a whole lot of warning when they get ready to close,” Ms. Hughes said.

“Small-cap funds do have a tendency to open and close more frequently than other mutual funds,” Ms. Norton said. “The liquidity issue is a constant concern, and it’s easier to bump up to that limit,” she said. “There are less shares outstanding for a small-cap company.”

LARGE-CAP BIAS

But some advisers simply aren’t interested in small-caps; they prefer the perceived safety of large-cap funds.

“Big companies can get credit easier,” said Scott Toms, chief investment officer at Cornerstone Wealth Management Group of Hagerstown, Md., which manages $150 million in assets.

“It’s a challenging environment right now. If we enter a recession, small-cap stocks tend to struggle, especially on the growth side,” Mr. Toms said.

“We’re trying to get out front of long-term trends, but we’re not going to get too risky with our investors.”

E-mail Sue Asci at [email protected].