By Philip van Doorn, MarketWatch
Amy Zhang, manager of the Alger Small Cap Focus Fund, explained last April how she had improved the fund’s performance since taking over the portfolio in 2015. She hasn’t lost her touch since that conversation.
Here’s a link to the April 2018 interview in which Zhang explained her stock-selection process in detail. Since April 11, the day before that interview was published, the Alger Small Cap Focus Fund’s class A shares /zigman2/quotes/207263247/realtime AOFAX +0.20% have returned 19%, while the Russell 2000 Growth Index /zigman2/quotes/210598133/delayed XX:RUO +1.61% has declined 1.6%. (During that same period, the Dow Jones Industrial Average /zigman2/quotes/210598065/realtime DJIA +0.98% has returned 3.8% and the S&P 500 Index /zigman2/quotes/210599714/realtime SPX +1.09% has returned 4.2%).
At the time of the first interview, the fund had $804 million in assets and a four-star rating from Morningstar for its class A shares. Since then, the fund has more than tripled to $2.7 billion in assets and now has a five-star rating (the highest) from Morningstar for class A.
That is remarkable, especially when you consider how painful the fourth-quarter price action was. During a follow-up interview last week, Zhang said: “The most important thing is letting the market serve us, use volatility as our friend and focus on risk/reward.”
As new money continued to pour into the fund, she would increase positions she felt represented the best value at that time, based on volatile price action.
“We do a lot of stress tests,” she said. “Having a solid bear price, when assumptions are so low/pessimistic — that is what I call a margin for safety. Understanding when to buy serves me very well. Buying low always works.”
She said that for three years, through Dec. 31, the fund captured 122% of the benchmark Russell 2000 Growth Index’s upside movement, while capturing only 80% of the downside.
Zhang described a successful investment in Apptio, which was acquired by Vista Equity Partners in January. The Alger Small Cap Focus Fund began buying shares of Apptio in November 2017, when they were trading around $22. Zhang said she was attracted to the company because it was a developer of technology business management (TBM) software used to “automate and optimize IT budgets.”
Annual revenue was about $200 million when Zhang decided to begin buying shares, and she expected it to double in the next three to five years, in part because the company “was executing well and expanding into government.”
“For me there is a lot of pattern recognition. I like to see companies that are already dominant, but then expanding into another large market, which is probably even stickier,” she said.
So Apptio was among the fund’s top holdings in the third and fourth quarters of 2018. But Apptio disappointed investors with third-quarter sales coming in below expectations, which Zhang wasn’t concerned about, because “it was a result of a change in the billing terms, not really a fundamental weakness.”
So Zhang was buying on weakness, in the $23 to $24 range late in October, before Vista’s deal taking out Apptio at $38 a share was announced Nov. 11.
“That was a great example of using volatility as our friend and not to let the market action dictate my behavior,” she said.
CareDX /zigman2/quotes/200138382/composite CDNA +0.43% was the second-largest holding of the Alger Small Cap Focus Fund as of Dec. 31. The company provides diagnostic testing for heart-transplant patients, and has more recently moved into testing for kidney transplants, with the goal of preventing organ rejection.
The company’s AlloSure tests are noninvasive and detect fragmented DNA to determine if a transplanted kidney has suffered a graft injury, to monitor a patient for possible reject of the organ.