By David Snowball

This fund has been liquidated.

Objective and Strategy

Stewart Capital Mid Cap Fund seeks long-term capital appreciation.  It invests, primarily, in domestic midcap stocks.  While it is technically a “diversified” fund, the managers warn that they prefer to invest in “a relatively small number of intensively researched companies.”  They operationalize “relatively small” as 30-60.  They target firms that don’t need “large amounts of leverage to execute their business plan” and firms with sustainable business advantages (favorable demographics and long-term trends, high barriers to entry, good management teams, and high returns on invested capital).

Adviser

Stewart Capital Advisors, LLC, was founded in August 2005.  It is a wholly-owned subsidiary of S&T Bank, headquartered in Indiana, PA.  As of December 31, 2011, Stewart had $965 million in assets under management.

Managers

Matthew A. Di Filippo, Charles G. Frank, Jonathan V. Pavlik, Malcolm E. Polley, Helena Rados-Derr and Nicholas Westric.  Mr. Di Filippo is the senior manager and the adviser’s investment strategist.  Mr. Polley is president and CIO.  His investing career started on Black Monday, 1987 and includes 25 years of primarily-midcap investing.  Except for Ms. Rados-Derr and Mr. Westric, the managers have all been with the fund since inception.  Each of the managers also handles something like 100-300 private accounts.

Management’s Stake in the Fund

Modest.  Three of the managers have invested between $10,001-50,000 in the fund: Polley, Di Filippo and Pavlik.  The others have invested under $10,000.  I expressed my concern about such modest commitments to President Polley.  He writes:

I could require that staff invest solely in the fund, but realize that a portfolio that is solely mid-cap oriented for some folks does not meet their risk parameters.  Also, I want staff to invest in the fund on its merits. That said, I have exactly two investments: S&T Bank stock and the Stewart Capital Mid Cap Fund.  I also have two children in college and have been using some of my investment in that fund to pay for that expense.  So, I believe I put my money where my mouth is.

Opening date

December 29, 2006. The fund converted to no-load on April 1, 2012.

Minimum investment

$1,000 or $100 for accounts with an automatic investment plan.

Expense ratio

1.50%, after waivers, on assets of $37.0 million.

Comments

I wandered by the Stewart Capital booth at Morningstar Investment Conference in June, picked up the fund’s factsheet and reports, and then stood there for a long time.  Have you ever had one of those “how on earth did I manage to miss this?” moments? As I looked at the fund’s record, that’s precisely what went through my mind: small, no-load, independent fund, great returns, low risk, low minimum investments.  Heck, they’re even in Steeler Country.  How on earth did I manage to miss this?

Part of the answer is that Stewart was not always a no-load fund, so they weren’t traditionally in my coverage universe, and their marketing efforts are very low-key.

There’s a lot to like here. The two reliable fund rating services, Morningstar and Lipper, agree that SCMFX is at the top of the midcap pack in both risk management and returns.  Here’s the Morningstar snapshot:

(Morningstar ratings, as of 10/30/12)

Morningstar’s estimate of tax-adjusted returns places Stewart in the top 1% of mid-cap funds over the past five years.

Lipper supports a similar conclusion:

(Lipper Leaders ratings, as of 10/30/12)

The fund has a striking pattern of performance over time. Normally good funds make their money either on the upside or the downside; that is, they consistently outperform in either rising or falling markets. Stewart seems to do both.  It has outperformed its peer group in eight of eight down quarters in the past five years (2008 – Q3 2012) but in only four of 11 rising quarters. But it still wins in rising markets. In quarters when the market has been rising, SCMFX gains an average of 10.65% versus 10.58% for its peer group, reflecting the fact that its “up” quarters rarely trail the market by much and sometimes lead it by a lot.

When I asked the simple question, “which mid-cap funds have been as successful? And screened for folks who could match or better Stewart over the past one, three and five year periods, I could find only four funds in a universe of 300 midcaps. Of those, only one fund, the $1.6 billion Nicholas Fund (NICSX), was less volatile.

That’s a distinguished record in a notably volatile market: 10 of the past 23 quarters have seen double-digit gains (six) or losses (four) for midcap stocks.

The fund is distinguished by effective active management. They buy the stocks they expect to outperform, regardless of the broader market’s preferences. They target stocks where they anticipate a 15% annual rate of return and which are selling at a discount to fair-value of at least 15%. Their question seems to be, “would we want to own this whole company?”  That leads them to buy businesses where the industry is favorably positioned (they mostly avoid financials, for example, because the industry only thrives when assets are growing and Stewart suspects that growth is going to be limited for years and years) and the individual firm has exceptional management. An analysis of the portfolio shows the result. They own high quality companies, ones which are growing much more quickly (whether measured by long-term earnings, cash flow, or book value) than their peers.  And they are buying those companies at a good price; their high-quality portfolio is selling at a slight discount (in price/earnings, price/sales, price/cash flow) to their peers.

Bottom Line

This is arguably one of the top two midcap funds on the market, based on its ability to perform in volatile rising and falling markets. Their strategy seems disciplined, sensible and repeatable. Management has an entirely-admirable urge “to guard against … making foolish decisions” based on any desire to buy what’s popular at the moment.  They deserve a spot on the due diligence list for anyone looking to add actively-managed, risk-conscious equity exposure.

Fund website

Stewart Capital

Fact Sheet

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