Fund name: Walthausen Small Cap Value (WSCVX)

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., 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, Walthausen & Co. controls the decision making process on important management issues, such as limiting assets under management in order to maximize its clients' returns.  In September 2007, Mr. Walthausen 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's 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, as noted above, he's now 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: 1.48% on an asset base of about $25 million (as of 12/30/09).  Morningstar reports a higher asset base ($70 million) but I can’t find that number either in the SEC filings or on the fund’s website.

Comments: Walthausen Value is 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 scoring model to identify companies that are trading at a discount to intrinsic value.”  Like many successful investors, he seems to focus on whether there’s likely to be sustainable free cash flow, which would allow a firm to provide its own financing for growth – either in the company or in dividends.  He tries to figure out whether management has a plan to sustain cash flow and whether they can make the plan work.

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.   

The fund is off to a very creditable start in that direction.   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 – 3/29/10 (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 – 3/29/10 (that is, the period of the ferocious rally off the March market bottom). 

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 rather high, though noticeably lower than Paradigm’s, despite Paradigm’s larger asset base.  Turnover, at 130%, is neither stunningly high or low.  That said, Mr. Walthausen has invested through a series of very different market conditions and has produced consistently top-decile returns throughout.   This little 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 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.