Walthausen Small Cap Value Fund (WSCVX), September 2011

By Editor

Objective

The Fund pursues capital appreciation by investing in small cap stocks.  For their purposes, “small cap” is under $2 billion at the time of purchase.  The manager reserves the right to go to cash as a temporary move.

Adviser

Walthausen & Co., LLC.  Walthausen & Co., LLC. is an employee-owned  investment adviser located in Clifton Park, NY.  Mr. Walthausen founded the firm in 2007.  It specializes in small- and mid-cap value investing through separate and institutional accounts, and its one mutual fund. Being employee owned, Mr. Walthausen and team control the decision making process on important management issues such as limiting assets under management in order to maximize their client’s returns. In September 2007, he was joined by the entire investment team that had worked previously with him at Paradigm Capital Management, including an assistant portfolio manager, two analysts and head trader. Subsequently this group was joined by Mark Hodge, as Chief Compliance Officer, bringing the total number of partners to six.

Manager

John B. Walthausen. Mr. Walthausen is the president of the Advisor and has managed the fund since its inception. Mr. Walthausen joined Paradigm Capital Management on its founding in 1994 as a Portfolio Manager. Mr. Walthausen was the lead manager of the Paradigm Value Fund from January 2003 until July 2007 and oversaw approximately $1.3 billion in assets.  He’s got about 30 years of experience and is, as I noted above, supported by the team from his former employer.

Inception

February 1, 2008.

Management’s Stake in the Fund

Mr. Walthausen has over $1 million invested in the fund and also owns the fund’s adviser.

Minimum investment

$2,500 for all accounts.

Expense ratio

1.38% on an asset base of about $325 million (as of 07/30/2011).  When I first profiled the fund in April 2010, expenses were 1.48% on just $25 million in assets, so it seems unlikely that the fund will ever become inexpensive.

Comments

Walthausen Value started as Mr. Walthausen’s attempt to reproduce the success of his Paradigm Value (PVFAX) fund by using the same investment objectives, strategies and policies with his new fund.  It’s not entirely clear what those strategies are.  Mr. Walthausen maintains a pretty low profile and the prospectus refers only to “a proprietary valuation model to identify companies that are trading at a discount to intrinsic value.”  If a stock passes that valuation screen, Walthausen and his team construct detailed earnings and cash flow projections.  Those projections are driven, in part, by evidence of “internal drivers” of growth, such as new managers or new products.  They’ll frequently talk with company managers, and then decide whether or not to buy.

His strategy appears to be fairly adaptable.  In explaining the fund’s strong relative performance in 2008, he notes that it “was achieved by populating the portfolio with companies which, by and large, had strong balance sheets, conservative, bottom-line oriented managements, and products that were in reasonable demand from their customers” (Annual Report, 1/09).  His letter, written while the market was still falling, concludes with his belief that excess negativity and a tumbling valuation meant “that outsized returns become a real possibility.”  Six months later, as he began harvesting those outsized returns, the portfolio had been moved to overweight cyclical sectors (e.g., information tech and consumer discretionary) and underweight defensive ones.

Mr. Waltausen’s public record dates to the founding of Paradigm Value.  His ability to replicate PVFAX’s record here would be an entirely excellent outcome, since his record there was outstanding.  The SEC believes the funds are close enough to allow Paradigm’s record into Walthausen’s prospectus.

  Last year at PVFAX 

7/31/06- 7/31/07

Last 3 years at PVFAX 

7/31/04 – 7/31/07

From inception to departure 

1/1/03 – 7/31/07

Paradigm Value 21.45 21.55 28.82
S&P 600 14.11 14.63 18.48
Russell 2000 Value 7.67 13.42 18.86

The fund has quickly earned itself a spot among the industry’s elite.  It returned over 40% in each of its first two full years of operation.  Its 2011 performance (through 08/25/2011) is -12.6%, about average for a small-value fund.

Since the fund has an elite pedigree, it makes sense to compare it to the industry’s elite.  I turned to Morningstar’s list of small core “analyst pick” funds.   Morningstar’s analyst picks are their “best ideas” funds, selected category-by-category, on the basis of a mix of quantitative and qualitative factors: thoughtful strategies, experienced management, low expenses, high stewardship grades and so on.  I tested Walthausen against those funds for two time periods.  The first is 2/1/08 – 7/30/2011 (that is, inception to the present).  A skeptic might argue that that comparison is biased in Walthausen’s favor, since it was likely still holding a lot of start-up cash as the market imploded.  For that reason, I also included the period 3/2/09 – 3/2/10 (that is, the year of the ferocious rally off the March market bottom).

$10,000 would have become . . . Since inception Year after the market bottom
Walthausen Small Cap Value $16,120 $24,000
Royce Special (RYSEX) 13,000 16,700
Paradigm Value (PVFAX) 12,200 18,300
Vanguard Tax-Managed Small Cap (VTMSX) 11,800 18,800
Bogle Small Cap Growth (BOGLX) 11,400 20,400
Third Avenue Small-Cap Value (TASCX) 10,000 17,100
Bridgeway Small-Cap Value  (BRSVX) 9400 18,400

When I last ran this comparison (April 2010), the funds ended up in exactly the same order as they do today (August 2011).

The majority of Walthausen’s investors come by way of Registered Investment Advisers, a fairly sophisticated group who don’t tend to be market timers.  As a result, the fund saw very little by way of outflows during the summer turbulence.  While closure is not imminent, investors do need to plan for that possibility.  Mr. Walthausen manages both his fund and separate accounts.  Between them, they have $530 million in assets.  He anticipates closing the strategy, both accounts and the fund, was that total reaches $750 million.  That’s well below the $1.3 billion he managed at Paradigm and could come in the foreseeable future.

Bottom line

There are, of course, reasons for caution.  Mr. Walthausen, born in 1945, is likely in the later stages of his investing career.  The fund’s expenses are above average, though its returns are higher still.  Mr. Walthausen has invested through a series of very different market conditions and has produced consistently top decile returns throughout.   This fund keeps rising to the top of my various screens and seems to be making a compelling case to rise on yours as well.

Company link

Walthausen Funds homepage, which is a pretty durn Spartan spot but there’s a fair amount of information if you click on the tiny text links across the top.

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