FBR Small Cap's Controversial Change

Charles Akre's FBR Small Cap earned a place on the Kiplinger 25 through superb long-term performance. In the ten years through September 21, the fund (symbol FBRVX) returned an annualized 15%, more than double the gain of the Russell 2000 index. Over the past five years, Small Cap has logged an even more impressive 24% annualized.

Despite its success, FBR recently announced that it will change the fund's name to FBR Focus on November 1 and modify the prospectus to allow Akre, the subadviser, to invest in companies of any size. This has stirred controversy, but will it fundamentally change the fund or Akre's investing style? No, that's highly unlikely.

In a way, the fund is a victim of its own success. Akre buys and holds -- his annual turnover is a minuscule 3% -- so many of the companies he invested in when they were small have sprouted into mid-caps.

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For example, he has a 30-fold return in Penn National Gaming (PENN), his largest position, which he has held since 1996. And the gains in his other large holdings, including American Tower (AMT), CarMax (KMX) and Markel (MKL), are also huge.

The fund's current prospectus says 80% or more of its assets should be devoted to small caps, which prevents Akre from adding to existing holdings such as Penn National. "We're trying to be in a position where we can water our flowers and cut our weeds, instead of the reverse," says Akre, who operates out of Middleburg, Va. "We don't want to be forced to sell something since it's successful."

The compliance issue became more problematic for FBR and Akre after the fund, which had been closed for more than two years, reopened to new investors last January. By May, Akre says, $550 million of net inflows had poured in.

As of June 30, 30% of the fund was in cash, which counts as non-small cap assets for Securities and Exchange Commission regulatory purposes. FBR's compliance advisers said that unless Akre -- a patient and disciplined investor -- put the money to work quickly, the fund could be out of compliance. Hence the move to rejigger the prospectus.

Akre says that this will the third name change in the fund's 11-year history. "Throughout each of the prior name changes there was no change in investment style, and there is no planned change in investment style," except that he'll be allowed to invest freely in mid-size companies. "We're not changing our stripes here at all."

The one strike against this fund is that its large cash holdings -- currently about $475 million, Akre says -- will drag down returns in a rising market, as has been the case so far this year (Small Cap is up only 4% year to date). If the market falls, Akre will have plenty of ammunition to put to work. And he won't be wearing handcuffs.