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Found: A Great Small-Cap Opportunity

One by one, the best small-company funds have closed their doors to new investors. New investors have had to settle for less-than-perfect alternatives. But here's a hidden gem.

Looking for a great small-company fund that's still open to new investors? Look no more. Champlain Small Company Adv (symbol CIPSX), managed by Scott Brayman, is the most attractive such fund I've spotted in ages.

The other superior small-cap funds have closed their doors to staunch the inflow of assets. Small-cap funds usually stumble when they take in too much money.

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Since opening for business in late 2004, Champlain's record has been good, but nothing to pound the table over. It returned 10% last year, beating the average small-cap-growth fund by four percentage points. This year it's up 1% -- about two points better than its average peer.

It's Brayman's record at his last job that knocks your socks off. He ran Sentinel Small Company A from November 1995 to September 2004 -- returning an annualized 15%. That beat the Russell 2000 small-cap index by an average of 11 percentage points per year and the Russell 2000 small-cap growth index by an average of six percentage points per year, according to Morningstar. If those aren't pound-the-table numbers, I don't know what are.

And that's not all. Brayman displayed remarkable consistency at Sentinel, trailing the average small-cap-growth fund only in the bull market years of 1999 and 2003. What's more, three of Champlain's four analysts are also Sentinel veterans -- increasing my confidence that Brayman can continue to put up superb numbers.

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I like my small-cap funds small, and Champlain fills the bill on this score, too. Brayman is managing $462 million in the Champlain fund and similarly managed private accounts, according to Judith O'Connell, a fund official. At Sentinel, Brayman managed as much as $1.5 billion. He says he won't manage more than $1.5 billion at his new firm.

Brayman, 45, doesn't like to talk to the media. O'Connell says it distracts from his main job: managing money. I like to talk to managers repeatedly to get a feel for whether they have the right stuff. But Brayman did make an appearance at Morningstar's annual conference in June, and he was impressive. So are his reports to shareholders.

Brayman's stock-picking style

Brayman exhibits a common-sense approach to investing in small caps. He looks first for high-quality companies. Currently, he's finding most of these among consumer stocks, health care stocks, industrials, tech stocks and financials.

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He's picky. For instance, he looks for tech companies whose products have a low risk of obsolescence; health care providers with minimal dependence on government payments; consumer firms with high brand loyalty and low fashion risk; and financial outfits that focus on profitable niches.

The next step is to look for high-quality numbers. He looks for high returns on equity (a measure of profitability), low debt, superior earnings and cash-flow growth, and stable business models. He also insists on quality management teams.

But he only buys these growth companies when their shares are selling at a discount to his estimate of their true value. Consequently, his holdings tend to toward the conservative end of the growth spectrum. Indeed, Sentinel lost a mere 4% in the gruesome 2000-02 bear market -- a period when most small-growth funds were clobbered but most small-value funds escaped serious damage.

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The fund lies almost on the cusp between small-cap growth and small-cap blend. That means it can serve as your only small-cap fund. Be aware, though, that Champlain will lag when growth stocks are hot.

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Brayman limits risk by owning lots of stocks, typically 75 to 100. He sticks relatively close to the sector weightings of the SP 600 small-cap index. He will neither overweight nor underweight a sector by more than 25%. That means he seeks to add value largely through superior stock picking. His average stock has a market value of $1.2 billion. Turnover runs 40% to 50% annually.

Brayman is finding plenty of high-quality stocks to buy these days. "We continue to find the best relative and absolute values in the least cyclical companies where we expect to see consistent and above average growth rates for revenue and operating cash flow," he said in a recent report to shareholders.

Additions to the fund in the first half of the year include Helix Energy Solutions (HLX), Interactive Data Corp. (IDC), Kennametal (KMT) and Laureate Education (LAUR).

The fund has a $10,000 minimum, or $3,000 for IRAs. But online broker Charles Schwab offers Champlain via its no-transaction-fee program with a $2,500 minimum investment, or just $1,000 for IRAs. Expenses are reasonable at 1.40% annually.

Steven Goldberg is a freelance writer and former senior associate editor of Kiplinger's Personal Finance magazine.

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