Objective and Strategy
The fund seeks long-term capital appreciation by investing in common stocks of U.S. small cap companies. Small caps are those in the range found in the Russell 2000 Value index, roughly $36 million – $3.0 billion. The manager looks for undervalued companies based, in part, on his assessment of the firm’s replacement cost; that is, if you wanted to build this company from the ground up, what would it cost? The fund has a compact portfolio (typically around 40 names). Nominally it “may make significant investments in securities of non-U.S. issuers” but the manager typically pursues U.S. small caps, some of which might be headquartered in Canada or Bermuda. As a risk management tool, the fund limits individual positions to 5% of assets and individual industries to 15%.
Huber Capital Management, LLC, of Los Angeles. Huber has provided investment advisory services to individual and institutional accounts since 2007. The firm has about $1.2 billion in assets under management, including $35 million in its two mutual funds.
Joseph Huber. Mr. Huber was a portfolio manager in charge of security selection and Director of Research for Hotchkis and Wiley Capital Management from October 2001 through March 2007, where he helped oversee over $35 billion in U.S. value asset portfolios. He managed, or assisted with, a variety of successful funds across a range of market caps. He is assisted by four other investment professionals.
Management’s Stake in the Fund
Mr. Huber has over a million dollars in each of the Huber funds. The most recent Statement of Additional Information shows him owning more than 20% of the fund shares (as of February 2012). The firm itself is 100% employee-owned.
June 29, 2007. The former Institutional Class shares were re-designated as Investor Class shares on October 25, 2011, at which point a new institutional share class was launched.
$5,000 for regular accounts and $2,500 for retirement accounts.
1.85%, after waivers, on assets of $22 million. The expense ratio includes separate marketing (12b1) and shareholder services fees, each at 0.25%.
Huber Small Cap Value is a remarkable fund, though not a particularly conservative one.
There are three elements that bring “remarkable” to mind.
The returns have been remarkable. In 2012, HUSIX received the Lipper Award for the strongest risk adjusted return for a small cap value fund over the preceding three years. (Its sibling was the top-performing large cap value one.) From inception through late May, 2012, $10,000 invested in HUSIX would have grown to $11,650. That return beats its average small-cap value ($9550) as well as the three funds designated as “Gold” by Morningstar analysts: DFA US Small Value (DFSVX, $8900), Diamond Hill Small Cap (DHSCX, $10,050) and Perkins Small Cap Value (JDSAX, $8330).
The manager has been remarkable. Mr. Huber was the Director of Research for Hotchkis-Wiley, where he also managed both funds and separate accounts. In six years there, his charges beat the Russell 2000 Value index five times, twice by more than 2000 basis points. Since founding Huber Capital, he’s beaten the Russell 2000 Value in three of five years (including 2012 YTD), once by 6000 basis points. In general, he accomplishes that with less volatility than his peers or his benchmark.
The investment discipline is remarkable. Mr. Huber takes the business of establishing a firm’s value very seriously. In his large cap fund, his team attempts to disaggregate firms; that is, to determine what each division or business line would be worth if it were a free-standing company. Making that determination requires finding and assessing firms, often small ones that actually specialize in the work of a larger firm’s division. That’s one of the disciplines that lead him to interesting small cap ideas.
They start by determining how much a firm can sustainably earn. Mr. Huber writes:
Of primary importance to our security selection process is the determination of ‘normal’ earnings. Normal earnings power is the sustainable cash earnings level of a company under equilibrium economic and competitive market conditions . . . Estimates of these sustainable earnings levels are based on mean reversion adjusted levels of return on equity and profit margins.
Like Jeremy Grantham of GMO, Mr. Huber believes in the irresistible force of mean reversion.
Over long time periods, value investment strategies have provided greater returns than growth strategies. Excess returns have historically been generated by value investing because the average investor tends to extrapolate current market trends into the future. This extrapolation leads investors to favor popular stocks and shun other companies, regardless of valuation. Mean reversion, however, suggests that companies generating above average returns on capital attract competition that ultimately leads to lower levels of profitability. Conversely, capital tends to leave depressed areas, allowing profitability to revert back to normal levels. This difference between a company’s price based on an extrapolation of current trends and a more likely reversion to mean levels creates the value investment opportunity.
The analysts write “Quick Reports” on both the company and its industry. Those reports document competitive positions and make preliminary valuation estimates. At this point they also do a “red flag” check, running each stock through an 80+ point checklist that reflects lessons learned from earlier blow-ups (research directors obsessively track such things). Attractive firms are then subject to in-depth reviews on sustainability of their earnings. Their analysts meet with company management “to better understand capital allocation policy, the return potential of current capital programs, as well as shareholder orientation and competence.”
All of that research takes time, and signals commitment. The manager estimates that his team devotes an average of 260 hours per stock. They invest in very few stocks, around 40, which they feel offers diversification without dilution. And they hold those stocks for a long time. Their 12% turnover ratio is one-quarter of their peers’. We’ve been able to identify only six small-value funds, out of several hundred, that hold their stocks longer.
There are two reasons to approach the fund with some caution. First, by the manager’s reckoning, the fund will underperform in extreme markets. When the market is melting up, their conservatism and concern for strong balance sheets will keep them away from speculative names that often race ahead. When the market is melting down, their commitment to remain fully invested and to buy more where their convictions are high will lead them to move into the teeth of a falling market. That seems to explain the only major blemish on the fund’s performance record: they substantially trailed their peers in September, October and November of 2008 when HUSIX lost 46% in value. In fairness, that discipline also set up a ferocious rebound in 2009 when the fund gained 86% and the stellar three-year run for which they earned the Lipper Award.
Second, the fund’s fees are high and likely to remain so. Their management fee is 1.35% on the first $5 billion in assets, falling to 1% thereafter. Management calculates that their strategy capacity is just $1 billion (that is, the amount that might be managed in both the fund and separate accounts). As a result, they’re unlikely to reach that threshold in the fund ever. The management fees charged by entrepreneurial managers vary substantially. Chuck Akre of Akre Focus (AKREX) values his own at 0.9% of assets, John Walthausen of Walthausen Small Cap Value (WSCVX) charges 1.0% and John Deysher at Pinnacle Value (PVFIX) charges 1.25%, while David Winter of Wintergreen (WGRNX) charges 1.5%. That said, this fund is toward the high end.
Huber Small Cap has had a remarkable three-year run, and its success has continued into 2012. The firm has in-depth analyses of that period, comparing their fund’s returns and volatility to an elite group of funds. It’s clear that they’ve consistently posted stronger returns with less inconsistency than almost any of their peers; that is, Mr. Huber generates substantial alpha. The autumn of 2008 offers a useful cautionary reminder that very good managers can (will and, perhaps, must) from time to time generate horrendous returns. For investors who understand that reality and are able to tolerate “being early” as a condition of long-term outperformance, HUSIX justifies as close a look as any fund launched in the past several years.