401(k) Fund Spotlight: Loomis Sayles Small Cap Value
Summary LSSCX is really a small cap “core” or “blend” fund. LSSCX has consistently beaten the Russell 2000 Index by at least 2% over all relevant, historical periods. With almost 1/3 of the fund in financials and little exposure to utilities, consumer staples, and REITs, the fund is well positioned for a rising rate environment. Introduction I select funds on behalf of my investment advisory clients in many different defined contribution plans, namely 401(k)s and 403(b)s. I have looked at a lot of different funds over the years. 401(k) Fund Spotlight is an article series that focuses on one particular fund at a time that is widely offered to Americans in their 401(k) plans. 401(k)s are now the foundational retirement savings vehicle for many Americans. They should be maximized to the fullest extent. A detailed understanding of fund options is a worthwhile endeavor. To get the most out of this article, it is helpful to understand my approach to investing in 401(k)s . I strive to write these articles for the benefit of the novice and professional. Please comment if you have a question. I always try to give substantive responses. Loomis Sayles Small Cap Value Fund The Loomis Sayles Small Cap Value Fund has the following share classes: If the fund is an option in your 401(k), it will likely come in the form of the I (institutional) or R (retail) shares. These two share classes are also much older and hold most of the overall fund’s assets. The expense ratio for the I shares is 1.04% and for the R shares it is 1.29%. For the purposes of this article, I will assume the I shares are being discussed and name the fund by its ticker – LSSCX . The fund is closed to new investors. Most readers, if they have access to the fund, will have it only through their 401(k). LSSCX is best classified as a small capitalization (“cap”) core (or blend) fund. Small cap companies are loosely defined as having a market capitalization of less than $2 billion. The “core” or “blend” description means that the fund owns stocks described both as growth and value. Performance Evaluation Loomis Sayles is a mutual fund outfit best known for its prowess in the bond market and their flagship Bond Fund, the Loomis Sayles Bond Fund (MUTF: LSBDX ). The immediate question for us is, “Can they pick stocks?” and “Can they pick small cap stocks?” I’ll let the numbers do the talking. The following table compares the performance of LSSCX to its benchmark index, the Russell 2000: as of Sept 30, 2015 1 Year Return 3 Year Return 5 Year Return 10 Year Return Loomis Sayles Small Cap Value – Inst 1.2% 11.7% 12.3% 7.6% Russell 2000 Index -1.6% 9.2% 10.2% 5.4% Excess Return 2.8% 2.5% 2.1% 2.2% The fund has beaten the index by at least 2% over the last 1, 3, 5, and 10-year periods (as of September 30, 2015). This is a consistent record of excess returns which clearly makes the fund a better option than owning the index. The following table compares the performance of LSSCX to its peers, as represented by the Lipper Small Cap Core Index. This data was taken from Barrons . as of Oct 31, 2015 1 Year Return 3 Year Return 5 Year Return 10 Year Return Loomis Sayles Small Cap Value – Inst .7% 14.3% 13% 8.6% Lipper Small Cap Core Peer Index .7% 13.4% 11.7% 7.5% Excess Return 0% .9% 1.3% 1.1% Over the last year, the fund is even with its broader peer group, but has out performed the average over the last 3, 5, and 10-year periods (as of October 31, 2015). Over the last 5-year period the fund finished in the 22nd percentile of its peer group and over the last 10-year period it finished in the 15th percentile. This means that it outperformed 85% of all other small cap core oriented funds over the last 10 years. From a performance standpoint, LSSCX can best be described as a superior option to the index and an above average option when compared to its peers. Additional Performance Considerations It is important to realize that LSSCX is not going to give you any sort of exceptional performance (e.g., 5%+) over its Russell 2000 index benchmark over a longer period of time. This is because the fund typically holds 150 to 180 different stocks (152 right now), with no one stock comprising more than 1.5% of the fund. The fund is just too overly diversified to vastly outperform the index. That being said, I view the consistent 2% excess returns as very good. Loomis Sayles “rigorous fundamental, bottom-up analysis” (as they describe it) adds value and makes the fund a better option than an index fund. It would be interesting to see Loomis Sayles launch a more concentrated small cap fund that owns what they think are their very best ideas. I am thinking of the Invesco Select Companies Fund (MUTF: ATIAX ), which I recently wrote about, which invests in the managers best 25 small cap ideas. Well Positioned for Rising Rates Here is how LSSCX’s assets were distributed across sectors, as of September 30, 2015: Financials – 31.5% Industrials – 18.4% Consumer Discretionary – 18.3% Information Technology – 14.8% Healthcare – 4.2% Consumer Staples – 3.5% Materials – 2.9% Utilities – 2.6% Energy – 2.3% Telecom – 0% Almost one third of the fund is invested in the financial sector. In fact, the fund’s 2 largest holdings are Signature Bank (NASDAQ: SBNY ) and Cathay General Bancorp (NASDAQ: CATY ). These small banks would benefit from a rising rate environment as their net interest margin expands. By this I mean they could continue to pay depositors 0% to .25% while at the same time increasing their rates on auto loans, mortgages, and commercial loans, netting more profit. The fund has little exposure to utilities and consumer staples stocks that could suffer as their high dividends become less appealing in an environment of higher bond yields. Furthermore, digging through the holdings I can see that the fund also has minimal exposure to real estate investment trusts (“REITs”), which could also suffer for the same reason. I am not expecting substantially higher rates for several more years, but wanted to point this out for some investors who may have a more immediate concern. Rising rates in the U.S. would also imply a strengthening U.S. economy which would benefit U.S. small cap stocks. Valuation If LSSCX has a weakness in the current environment it is the low dividend yield, which currently only runs about .6%. However, the fund is attractive from a valuation standpoint. As of September 30, 2015, it had a forward price to earnings multiple (“P/E”) of 15.96. This is slightly below the index and gives credence to the fund’s “value” slant. (It does call itself small Cap Value, even though it is really a small cap core or blend fund.) I have no problem sacrificing dividend yield for lower valuations. Strategic Positioning I have really warmed to U.S. small cap stocks over the last few months in the 401(k) plans I manage for clients. It seems little noticed, but valuations have come down substantially to the point that they are now broadly inline with U.S. large cap stocks. Furthermore, the 2-year chart of the Russell 2000 Index looks compelling: ^RUT data by YCharts The index put in a higher low in 2015 than it did in 2014 and appears ready to break out to new highs. Am I predicting this? No. I am just considering a scenario where the U.S. dollar continues to rise, putting pressure on the earnings of U.S. multinationals but buoying the attractiveness of U.S. small cap companies with little international exposure. In such a scenario, I could see the S&P 500 index treading water while the Russell 2000 index logs some high, single-digit gains. Conclusion The Loomis Sayles Small Cap Value Fund is a good option in the current global macroeconomic environment. 401(k) investors may want to consider giving it the nod, or at least a higher weighting, over comparable small cap fund options and especially over small cap index funds. Investing Disclosure 401(k) Spotlight articles focus on the specific attributes of mutual funds that are widely available to Americans within employer provided defined contribution plans. Fund recommendations are general in nature and not geared towards any specific reader. Fund positioning should be considered as part of a comprehensive asset allocation strategy, based upon the financial situation, investment objectives, and particular needs of the investor. Readers are encouraged to obtain experienced, professional advice. Important Regulatory Disclosures I am a Registered Investment Advisor in the State of Pennsylvania. I screen electronic communications from prospective clients in other states to ensure that I do not communicate directly with any prospect in another state where I have not met the registration requirements or do not have an applicable exemption. Positive comments made regarding this article should not be construed by readers to be an endorsement of my abilities to act as an investment adviser.