The stock market crash of 2008 was brutal for all mutual funds. The vast majority of them hemorrhaged value, and their portfolio managers spent much of the year pointing to the safely undeniable fact that the Standard & Poor's 500 Index fell 37% that year, and arguing to their clients that they wouldn't have done much better by taking their money across the street to a competing fund.
By and large, the last thing on any manager's mind was to use the crash as a strategic opportunity to chart a new course, clean up his fund's portfolio, change the way it invested, begin again with a clean slate, and start delivering dramatically better returns than his peers.
Well, at least one manager did precisely that, and I was fortunate enough to sit down for lunch with him in Midtown Manhattan a few months ago. Brian Stack is the portfolio manager of the Pioneer Growth Opportunities Fund (PGOFX), a small-cap growth stock fund that truly stunk until Pioneer Investments in Boston decided a management change was in order. In September 2008, Pioneer hired Stack and his team away from the hedge fund firm they'd founded, Long Trail Investment Management, and gave them carte blanche to do as they pleased with Growth Opportunities.
Not long after Stack took over, Growth Opportunities was a shooting star. The fund wasn't just rising with the rally of 2009 -- it was outpacing other small-cap growth funds. In 2009, the fund grew 43%, beating 89% of its peers. So far this year, the fund is up 9.2%, more than double the S&P 500, and it now has $650.1 million in assets.
The fund's performance is unrecognizable from previous years. In 2008, it fell 35.4%, almost in line with the S&P 500. In 2007, it fell 3.9% while the index grew 5.5%. In 2006, the fund grew only 4.8% while the index was up 15.8%.
A Fresh Start, and a Fresh Method
What are Stack and his team doing differently from the fund's previous managers? It's hard to know exactly what his predecessors were doing, since Pioneer won't bring them to the phone. According to Stack, they were using a quantitative investment process, which relies on computer programs to predict changes in stock prices.
"My purpose was to turn it into a bottom-up fundamental product," he says, referring to the more common investment process by which real live humans decide which companies to buy after visiting their offices, interviewing their managers and maybe even visiting their factories.
But Stack also had timing on his side. He was quick to recognize the stock market crash as an opportunity to clean out the portfolio and buy pretty much any stock he wanted because, in a year when the market fell faster than it had since the Great Depression, every stock out there was suddenly affordable. "Any manager in this business was at liberty to restructure their portfolio and look at the opportunities that arose," he says.
Buying Priceline at the Right Time
For growth managers like Stack, who are trained to buy expensive stocks under the assumption that they will keep trading upward, it was like being a kid in a candy store. He pounced on growth stocks that might have looked a little pricey before the crash. One was Priceline.com (PCLN), the Internet-based travel service, which had fallen 66% from $139.66 on May 13, 2008, to $47.07 on Nov. 16, 2008. Since then, Priceline has more than quadrupled in price, closing at $212.89 on May 13.
Stack thought investors had sold Priceline down for the wrong reason, and expected it to come back up once they came to their senses. "It was driven down by the presumption that consumers would not travel in a recession. But Priceline allowed consumers to name their own price, becoming part of the solution when hotels and airlines decided it was better to sell at a price point rather than allow rooms and seats to go empty," he says.
It's not easy to make such a great stock pick, particularly in the small-cap arena. Small-cap stocks are difficult to get a handle on because precious little market research is available on them. The research departments of Wall Street investment banks find it uneconomical to cover companies with market caps below $2 billion because they're too small for a trading desk to make much money from selling their stock, he says.
That makes for a labor-intensive exercise for Stack and his team, who travel farther to see small companies than they would to see an S&P 500 corporation. The small ones tend not to be based in cities with large airports. And because they are seen as risk assets, they are more volatile than S&P 500 stocks.
"We Don't Try to Shoot the Lights Out"
Add up all these headaches, and it can take decades of experience to get it right in the small-cap game, says Stack. He has been at it for 23 years, but that's not all he has going for him. Perhaps more importantly, Stack has a background in hedge funds, where he developed a sharp nose for risk-taking.
After more than eight years as a growth fund manager at MFS Investment Management, he left in 2001, the year after the dot-com crash, to co-found Cyllenius Capital, a hedge fund that BlackRock (BLK), the world's largest money management firm, acquired in 2002. Then he managed both mutual funds and hedge funds for BlackRock until 2004, when he and his team broke off on their own, forming Long Trail, where they stayed from 2005 to 2007.
To hear Stack tell it, he has surprised himself with Growth Opportunities' performance. "We don't try to shoot the lights out," he says. "We look at potential for revenue growth, healthy and defensive profit margins, and returns on invested capital."
That, of course, turned out to be a recipe for fast and sudden growth in the wake of the financial crisis.
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