Blending both value and growth has helped Jenny Jones dish out some pretty impressive yearly returns. Since she took over in 2003, the return of her Schroder US Smaller Companies Fund has soared almost 85 percent. For the last two years, Jones has also been managing the Schroder US Small and Mid-Cap Opportunities Fund. ‘We’re bottom-up stockpickers and focused on growth, but what distinguishes us from small-cap growth investors is our additional focus on the cash return on capital,’ she expands.
Jones studied political science at Yale then in 1980 joined Wall Street investment bank Drexel Burnham Lambert, the first company to market junk bonds. ‘I got a taste for the markets,’ she says. ‘I was always learning new areas and new niches; it was fascinating.’ Stints with Morgan Stanley and Oppenheimer Capital followed. Now Jones’ job is to hunt down the small and mid-cap minnows that fit her criteria of good prospects with steady cash flow. Sifting for stocks in this pool – her fund is roughly 75 percent small cap, 25 percent small to mid-cap – offers huge potential, she believes, simply because of the sheer scale of the underresearched small-cap market.
But with the possibility of a Democratic US president in under two years, Jones has been casting a watchful eye over her portfolio. ‘There’s been a knee-jerk reaction to anything related to defense or healthcare,’ she explains. ‘Some stocks have taken it quite hard, so it’s incumbent upon us to find companies that will hold up well.’
President Bush’s recent idea to shift insurance tax deductions from employers to workers could create healthcare opportunities, Jones thinks. ‘It’s an area where there has been a lot of inflationary pressure in the last ten years and there has been some good profitability,’ she says. ‘But healthcare firms with high profitability and costly Medicare reimbursement are subject to a lot of scrutiny, which could hit future profits.’
Jones says she’s much more likely to buy into a stock if management is also heavily invested – but not just in stock options. ‘Since the change in options expensing, there has been more debate on management issuing restricted stock,’ she comments. ‘I would prefer if management was forced to buy stock and own it outright, rather than the restricted route, which I think is giving away shareholder value before it’s accrued.’
Many of Jones’ small and mid-caps don’t have the spare cash to hire an IRO, so she regularly has a direct line to the CEO or CFO. Years of experience tell her when she’s hearing the truth or a watered-down version of it, she reckons. But Regulation FD has got in the way of the probing process. ‘Many are now very guarded about what they can say,’ Jones explains. ‘But I can ask roundabout questions and read body language. It’s not about getting information you’re not allowed to know; it’s about inferring.’
Comprehensive cross-checking
Jones’ other barometers include past performance and comprehensive cross-checking. Apart from meeting the companies themselves on a one-toone basis – because she doesn’t like to give other fund managers and analysts insight into her agenda – Jones and her team also spend a lot of time talking to suppliers and competitors.
She recalls researching a large healthcare firm that supplied surgical implants. ‘If you had relied on Wall Street coverage alone, you would have thought this company was in a very good position,’ she says. ‘But when we did the digging, we found it had a lot of competitive threats that had hardly been documented – and management did not clue us into that.’
Jones believes this lack of management honesty damages goodwill quickly, however painstakingly built up. ‘That’s where companies can do themselves a big disservice,’ she continues. ‘They go out on the road and are very positive, and follow it up the next quarter with very disappointing results, so they lose credibility.’
Smaller companies are generally more on top of their business, Jones says. And good external consistency helps cushion market volatility in the long run. Volatility could be on the rise with the advent of Fin 48, a new US Financial Accounting Standards Board (Fasb) rule that will let companies disclose their tax positions only if it is more likely than not they will survive an external audit examination (see Out of the shadows, page 41). ‘It’s going to lead to more volatility in tax rates,’ Jones states. ‘There’s no way you can ascertain some issues in quarterlies. Also, more companies are now valued on their real estate assets – what they own versus what they lease.’
A typical Jones stock – one that meets her Garp (growth at a reasonable price) criteria – is Informatica, a tech company focused on data integration, an area Jones believes has yet to be valued realistically by investors. ‘We owned its competitor, Ascential Software, which was bought out by IBM,’ she says. ‘Data integration is critical for corporations that use software from a variety of suppliers. It’s about getting systems to work together and extract data in different ways and, from the corporate IT perspective, that is a huge problem. Many US companies have been trying to cut costs, but now they need to generate revenues, and this company fits right into that mold.’
Cheap money, easy life
In the past, small companies often faced big obstacles in their attempt to borrow, usually because of a diminutive asset base. But cheap money and an increasing willingness to lend against cash flow as opposed to assets is making life easier for many smaller companies. It is precisely this gush of cheap, easy cash, however, that worries Jones.
‘I’m concerned about a global liquidity glut; I don’t think our Federal Reserve has the control over global liquidity that many believe,’ she explains. So what could be the lynchpin that slows down this whirling financial dervish? ‘I don’t know,’ she says. ‘But the liquidity bubble keeps spurting. I’m surprised the markets have been so strong.’
Merrill Lynch recently predicted a global credit crunch in 2007, warning clients to switch to more defensive sectors. Too many people have taken on too much risk while ignoring the slow drip-drip of rising interest rates, Merrill said. Jones hopes her portfolio combination of mispriced growth companies will buoy up her fund, whatever happens. ‘Our portfolio is working in every market environment,’ she says. ‘In a down market, our steady Eddies tend to hold up well, while our valuation discipline across the portfolio also helps us in difficult market environments.’ A landing, soft or hard, seems inevitable, but Jones appears prepared.
With all her experience working on Wall Street, what was the best piece of business advice she’s had? ‘Everything takes much longer than you think,’ Jones says carefully. ‘Everyone, for example, is talking about ethanol use now, and bidding the stocks up. Well, the true infrastructure that’s mandated for ethanol use will take many years to evolve. You see how markets hype things. Does anyone really understand this business before it becomes significant?’
