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Two Small-Cap Gems

Steven Goldberg

Expect T. Rowe Price Small Cap Value and Bridgeway Micro-Cap Limited to lead the charge when the market recovers.



One of the few good things about bear markets is that they give you an opportunity to buy into terrific funds that have long been closed to new investors. Case in point: Two excellent small-company funds, T. Rowe Price Small Cap Value (symbol PRSVX) and Bridgeway Micro-Cap Limited (BRMCX), recently reopened.

I'm not saying that either of these funds will make you money right away. In fact, their performance of late has been downright scary. Year-to-date through March 20, the Price fund had plunged 19% and the Bridgeway fund tumbled 22%. But over the long haul, this pair should stand you in good stead.

T. Rowe Price Small Cap Value

The Price fund is by far the safer bet. Manager Preston Athey, 60, has been investing professionally since 1978, and has piloted Small Cap Value since 1991. Over the past ten years through March 20, the fund returned an annualized 7%, putting it in the top 11% of funds that focus on undervalued small companies. Annual turnover is typically just 10% to 15%, meaning that Athey holds stocks, on average, for seven to ten years. Expenses are reasonable, at 0.82% annually.

Athey is an optimist, despite vivid memories of the 1973-74 bear market, which in terms of magnitude and duration was similar to the current debacle. Says Athey: "The economy will be as bad this time, maybe even worse. People will get hurt, but things will turn around. We've seen this movie before. We know how it ends."

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Athey thinks the market may be close to a bottom -- if it hasn't already hit it. "In past bear markets, you knew you were close to the bottom when even the best companies started going down. People were throwing in the towel." That was certainly the case in the days leading up to March 9, when both the Dow Jones industrial average and Standard & Poor's 500-stock index hit their bear-market lows (at least for now). Between that day and March 20, the Dow surged 10% and the S&P climbed 13%.

Athey is finding lots of compelling values. "Close to everything is cheap today," he says. "Dozens of companies are selling below tangible book value." (Tangible book value is assets minus liabilities, with intangibles such as patents and copyrights also subtracted.) Price-earnings and price-to-book-value ratios are low, although not at record lows. But interest rates, Athey notes, are much lower now than they were, for instance, at the 1982 market bottom, so stocks are better bargains today than they were then.

Athey is smart-and cautious. "I don't bet the farm on anything." And he's sticking to his proven methods. "I'm managing the portfolio the same way I have for 17½ years."

What does Athey look for in a stock? He examines such measures as P/E, price-to-book value, price-to-cash-flow, return on equity (a measure of profitability) and what he thinks a company would fetch if it were taken over. He also likes to see companies with strong balance sheets.

Athey prefers stocks that are covered by relatively few analysts and aren't heavily owned by big institutional investors. Such stocks offer value because they haven't yet been discovered.

He'll often buy relatively illiquid stocks-that is, stocks that don't trade a lot. "I'm not concerned about liquidity. If you buy over 8% of the outstanding shares of a company, you're not a stock holder, you're a stuck holder. I do that a lot." Athey can get away with this strategy because of his ultra-patient approach.

Bridgeway Micro-Cap Limited

The Bridgeway fund dances to a different beat. Where Price Small-Cap Value is conservative, Bridgeway Micro-Cap Limited is aggressive -- and is, therefore, best taken in small doses.

Bridgeway's manager, John Montgomery, 53, is a quant -- that is, he and his colleagues use sophisticated computer programs, which they write, to pick stocks. Although most of the Bridgeway funds have performed horribly over the past year, Micro-Cap Limited has lagged its peers for years.

Why even consider it? Because of the concept of "reversion to the mean," the tendency for something to return to the midline of a trend after performing above or below the trend for a long time. Montgomery uses essentially the same stockpicking models for a number of Bridgeway funds, which have better five-year records than Micro-Cap Limited (they differ only in the size of the companies they target.) There's no reason I can think of for Micro-Cap Limited to continue to do worse than its stable mates -- given that it's run using the same models.

But the returns really stink. Over the past five years through March 20, Micro-Cap Limited lost an annualized 10%. That put it in the bottom 11% among small-company-growth funds. Over the past ten years, however, the fund returned an annualized 6% -- better than all but 5% of its peers.

What's more, the fund's assets have fallen to $19 million, enabling Montgomery to buy and sell tiny companies without dramatically moving their share prices. That gives him a huge advantage compared with managers of other small-company funds with much larger asset bases. Sooner or later, I expect Montgomery and his three co-managers to steer Micro-Cap Limited back into the limelight.

Steven T. Goldberg (bio) is an investment adviser.



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