Deep Dive: These stock pickers have beaten their benchmark while giving fund holders needed diversification

“SMID” stands for small/mid-cap, which means the Cambiar SMID Fund by definition isn’t invested in stocks that dominate the headlines. The typical index-fund investor isn’t as diversified as they might think. For example, the top five stocks held by the $392 billion SPDR S&P 500 ETF Trust
SPY,
+0.24%
(Apple Inc.
AAPL,
-0.03%,
Microsoft Corp.
MSFT,
+0.01%,
Amazon.com Inc.
AMZN,
+0.11%,
Tesla Inc.
TSLA,
+0.51%
and Alphabet Inc.
GOOG,
+0.91%
GOOGL,
+0.86%
) make up 23% of its portfolio. Those five companies make up 43% of the $182 billion Invesco QQQ Trust
QQQ,
+0.47%,
which tracks the Nasdaq-100 Index
NDX,
+0.49%.

Andrew Baumbusch and Colin Dunn discussed their strategy for the Cambiar SMID Fund
CAMMX,
-0.77%,
which has about $140 million in assets and is rated four stars, the second-highest, by Morningstar. Cambiar Investors is based in Denver and had $5.4 billion in assets under management as of June 30.

The Cambiar SMID Fund’s benchmark is the Russell 2500 Value Index
R25IV,
+0.41%.
The Russell U.S. indexes are subsets of the Russell 3000 Index
RUA,
+0.28%,
which represents about 98% of publicly traded U.S. companies by market capitalization. The Russell 2500 Index
RUB,
+0.43%
leaves out the largest 500 by market cap. The Russell 2500 Value Index is made up of about 1,840 stocks in the full Russell 2500 that trade relatively low to book value and earnings, while having lower expected growth rates than stocks in the partially overlapping Russell 2500 Growth Index
R25IG,
+0.46%.

The fund was established in 2011. Here’s how its investor-class shares have performed against their benchmark, the Russell 2500 Growth Index, the full Russell 2500 Index and Morningstar’s Mid-Cap Blend mutual fund category through Aug. 17:

Total return – 2022

Average return – 3 years

Average return – 5 years

Average return – 10 years

Cambiar SMID Fund – Investor shares

-5.5%

13.1%

12.2%

12.4%

Russell 2500 Value Index

-4.9%

12.8%

9.1%

10.6%

Russell 2500 Growth Index

-17.3%

10.0%

11.4%

12.3%

Full Russell 2500 Index

-9.8%

12.4%

10.7%

11.7%

Morningstar Mid-Cap Blend category

-8.2%

12.2%

10.0%

11.0%

Sources: Morningstar, FactSet

In an interview, Baumbusch, who worked as an analyst at Franklin Templeton and other firms before joining Cambiar 2004, said limiting downside capture, relative to the benchmark index, was “particularly compelling” to the firm’s clients. A 10-year chart of total returns shows that the SMID Fund has generally undergone moderate declines when compared with those of its benchmark:

A comparison of financial performance and value measures provided by Cambiar based on Morningstar’s data illustrates the SMID Fund’s value characteristics compared with those of the Russell 2500 Value Index:

Selecting stocks for value within a quality ‘library’

Baumbusch said that analysts at Cambiar narrow the full universe of U.S. stocks of companies with market capitalization ranging from $500 million to $20 billion to a “library” of companies for potential investment.

“What we are trying to is identify companies where there is a structural product or market advantage that can be identified by the financial metrics they consistently put up for years,” he said.

Dunn, who worked as an analyst at Keefe, Bruyette & Woods before joining Cambiar in 2011, emphasized that he and colleagues, including analysts covering various market sectors, focus on companies with impressive long-term compound annual growth rates for earnings, as well as low levels of debt (illustrated on the last chart, above). He also emphasized the importance of purchasing stocks at attractive prices.

“The Russell 2500 tends to have a drawdown of 10% to 25% in any given year,” Baumbusch said, which provides opportunities to take advantage of lower prices for stocks within the library.

The fund is managed to be equal-weighted, a policy Baumbusch said was “grounded in humility.” The fund isn’t automatically rebalanced, as an index fund might be.

Dunn explained that weighting adjustments are based on the management team’s fair-value estimates. “We harvest some basis points back to a model weight. Then we look at business that have underperformed” in the stock market, he said.

“The top 10 is often a record of what has outperformed most recently … it is not necessarily a conviction weighting,” Baumbusch said.

A changing market

Baumbusch said “the emergence of a cost of capital this year has been a promising development from our perspective.” Higher interest rates, the end of fiscal stimulus and a change of direction by the Federal Reserve mean it is more difficult for companies to raise money. He pointed out that about 40% companies in the Russell 2500 aren’t profitable.

During the bull market through 2021, many stocks of rapidly growing companies soared, even though expected profits were years away. As business and financial conditions tighten, the market “should begin to winnow-out this ‘everybody wins’ paradigm,” Baumbusch said.

“We have thought that a cost of capital is very healthy for pricing assets and for value managers such as us, who try to deliver.” he added.

Fund holdings

Keeping in mind that the top holdings of a generally equally-weighted fund don’t necessarily indicate that those stocks are the most favored by the managers, here are the Cambiar SMID Fund’s top five and bottom five holdings (of 39) as of June 30:

Company

Ticker

Share of portfolio

Industry

Market cap. ($mil)

Total return – 2022 through Aug. 17

Arch Capital Group Ltd.

ACGL,
+0.51%

3.4%

Multi-Line Insurance

$17,541

7%

Lamb Weston Holdings Inc.

LW,
-0.43%

3.3%

Food: Specialty/Candy

$11,816

31%

Mercury Systems Inc.

MRCY,
-0.12%

3.3%

Aerospace & Defense

$2,969

-7%

WEX Inc.

WEX,
+1.74%

3.2%

Data Processing Services

$7,192

16%

Atmos Energy Corp.

ATO,
+0.31%

3.0%

Gas Distributors

$16,460

14%

Gentex Corp.

GNTX,
+1.60%

1.5%

Auto Parts: OEM

$6,767

-16%

GrafTech International Ltd.

EAF,
+0.93%

1.5%

Electrical Products

$1,796

-41%

IPG Photonics Corp.

IPGP,
+1.67%

1.5%

Semiconductors

$5,034

-42%

V.F. Corp.

VFC,
-1.49%

1.8%

Apparel/Footwear

$18,310

-34%

Amedisys Inc.

AMED,
+0.49%

1.9%

Medical/Nursing Services

$3,875

-26%

Sources: Cambiar Investors, FactSet

Click on the tickers for more about each company. You should also read Tomi Kilgore’s detailed guide to the wealth of information for free on the MarketWatch quote page.

Don’t miss: 20 bank stocks expected to benefit the most from rising interest rates as the Federal Reserve fights inflation

Hear from Ray Dalio at MarketWatch’s Best New Ideas in Money Festival on Sept. 21 and 22 in New York. The hedge-fund pioneer has strong views on where the economy is headed.