DGHM All-Cap Value: A Great Fund You’ve Never Heard Of
The sponsors of DGHM All-Cap Value (symbol DGHMX) picked a terrible time to launch their fund -- just four months before the worst bear market since the Great Depression. From the fund's inception on June 20, 2007, through May 27, it returned an annualized 3.9%. That doesn't sound especially impressive. But the fund has beaten its benchmark, the Russell 3000 Value index, by a whopping 7.2 percentage points per year, on average.
Over the past 25 years through March 31, the period for which DGHM has an audited record, private accounts using the firm's All-Cap Value strategy returned an annualized 12.4% before fees. That’s an average of 2.4 percentage points per year better than the Russell 3000 Value index, a broad-based index of statistically cheap stocks. Over the past ten years through March 31, it returned an annualized 9.5% before expenses, compared with 4.9% a year for the Russell index.
Aside from superb performance, DGHM is unusual in other ways. Each of its ten sector analysts makes the final buy and sell decisions on the stocks he or she tracks. Compensation is based largely on the five-year risk-adjusted performance of those picks. “It’s a pay-for-performance system,” says Bruce Geller, CEO of Dalton, Greiner, Hartman, Maher & Co., the New York City firm that runs the fund. I can’t think of a better way to pay stock pickers; the highly respected American funds, which are sold through brokers and other third parties, use a similar system.
DGHM employs a “team leader,” who acts as an administrator, not a manager. Jeff Baker, an analyst who covers the energy and health care sectors, currently fills that slot.
The analysts believe they add value almost entirely through their work on individual stocks. So they do little else -- they don’t pick sectors or engage in market timing. DGHM says it won’t let the fund’s cash position rise beyond 3% of assets. And the fund won’t deviate from the Russell 3000 Value index in its sector weightings by more than 25%. So, for instance, if the Russell’s technology weighting is 10%, the fund won’t hold less than 7.5% in tech or more than 12.5%. The fund usually owns 35 to 40 stocks, and it won’t make outsize bets on any stocks. Turnover is roughly 50% annually. Annual expenses are 1.27%.
Whatever wiggle room the fund has revolves around the size of the companies it can own. It can invest as much as 30% of its assets in stocks of small companies. Recently, however, the analysts have found more bargains among larger companies and faster-growing companies than usual.
Geller calls DGHM a “quality value” shop. The analysts look for companies that trade at cheap prices relative to earnings, sales and other measures. But they also want companies that are leaders in their niches, that boast strong free cash flow (what’s left after a company spends what’s needed to keep its businesses running), and that are run by managers who have a record of using that cash flow to pay higher dividends, buy back shares and pay down debt.
The DGHM folks worry a lot about “value traps,” stocks that look cheap but continue to fall in price as the underlying businesses deteriorate. That approach paid off big time during the 2007-09 bear market, when a number of large financial-services firms went under. Partly because DGHM didn’t own them, the fund lost only 47.5% during the 18-month-long bear market, compared with 59.9% for the Russell 3000 Value.
3M Co. (MMM), the St. Paul, Minn.-based industrial products conglomerate, is a current DGHM favorite. 3M, says Geller, is cheap relative to its competitors and its history, yet consistently exhibits a return on equity (a measure of profitability) of more than 20%. “It’s an innovation machine,” Geller says. “3M is granted more patents in a year than many countries.”
A more obscure DGHM pick is Mueller Industries (MLI), the nation’s leading maker of copper pipe used for plumbing and refrigeration. Mueller dominates its niche and is the low-cost provider, Geller says. Yet, he says, the stock is cheap. The stock trades at just 11.5 times anticipated earnings for the coming 12 months and only 0.6 times sales over the past 12 months.
Three of the dozen or so people who formed DGHM in 1982 still work there. Geller describes the firm’s success as “repeatable. There are no stars. Instead, there’s teamwork. We employ a disciplined and consistent process that we’ve followed, but have continued to refine, since inception.”
DGHM has many fine qualities. One other thing that impresses me about the firm is its determination to stay small. Altogether, it manages $1.7 billion, about half of that in the all-cap value strategy. The firm is committed to managing no more than $2.5 billion in that strategy. Given its superior record, it shouldn’t take it long to get there.
Steven T. Goldberg (bio) is an investment adviser in the Washington, D.C. area.