At Marcellus, we are big fans of giant data-hungry quant screens which can rigorously sift through years of data on thousands of companies and give us a small set of 25-30 companies on which can do detailed qualitative research. Given such proclivities, we found this piece in Barron’s to be a really interesting read. The article profiles a fund manager called Bob Bergson who runs a US$446mn fund called ‘Northern Small Cap Core’. Barron’s says, “While some fund managers devote the majority of their time to uncovering the very best companies, Bob Bergson has spent nearly a decade making sure that his $446 million Northern Small Cap Core fund avoids the very worst.
It helps that underperforming companies exhibit common traits: declining margins, too much debt, and inadequate cash flow, to name a few. Meanwhile, “successful companies tend to have very individual paths,” says Bergson, 54.”
Interestingly, rather than screening to get the best companies, Bergson screens to avoid the worst: “Bergson uses a factor-based approach to give investors exposure to the broader small-cap universe—minus the worst of the worst. The goal is to capture the outsize return characteristics of small companies, while keeping stock-specific risks and trading costs in check. Over the past decade, the fund (ticker: NSGRX) has returned an average of more than 12% a year, putting it ahead of 87% of its small-blend peers and the Russell 2000 index.”
Underlying this investment philosophy are some interesting insights from Bergson: ““I wanted to understand where you get rewarded for the risk you take and how to avoid the sorts of risks you don’t think you’re getting rewarded for,” says Bergson… “Some of the biggest outsize returns in the space come from the smallest segments of the small-cap universe,” he says, noting that stocks added to the Russell 2000 returned, on average, more than double the index in the year prior. Admittedly, these results are positively skewed—the stocks make it into the index because they outperformed—“but if you don’t have exposure to them, you miss out on a big portion of that upside,” he says. As an added benefit, microcap stocks have a slightly lower correlation to the broader market, he says. In a big selloff, he says, “What do investors sell first? It’s not the microcaps. It’s larger, more liquid securities.”
Alongside this unique investing philosophy, Bergson maintains low levels of churn in his portfolio: “Bergson and his team, which includes four co-managers, don’t screen microcaps for quality. Instead, they aim to own a large sample that reflects sector weightings of the Russell 2000, and keep trading to a minimum. “You let the market, in a sense, reward that exposure,” says Bergson, whose portfolio turnover was recently just 21%…. It’s far easier to identify companies that are least likely to succeed, he says. That emphasis on what not to buy helps minimize turnover and saves on trading costs. Eight of the fund’s recent top 10 holdings have been in the portfolio since Bergson took over in 2010…”
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