Objective

The Fund pursues long-term capital appreciation by investing primarily in common stocks of small and mid capitalization companies. Small and mid capitalization companies are those with market capitalizations of $4 billion or less at the time of purchase.  The Fund typically invests in 40 to 50 companies. The manager reserves the right to go to cash as a temporary move.

Adviser

Walthausen & Co., LLC, which is an employee-owned investment adviser located in Clifton Park, NY.  Mr. Walthausen founded the firm in 2007.  In September 2007, he was joined by the entire investment team that had worked previously with him at Paradigm Capital Management, including an assistant portfolio manager, two analysts and head trader. Subsequently this group was joined by Mark Hodge, as Chief Compliance Officer, bringing the total number of partners to six.  It specializes in small- and mid-cap value investing through separate and institutional accounts, and its two mutual funds.   They have about $540 million in assets under management.

Manager

John B. Walthausen. Mr. Walthausen is the president of the Advisor and has managed the fund since its inception. Mr. Walthausen joined Paradigm Capital Management on its founding in 1994 and was the lead manager of the Paradigm Value Fund (PVFAX) from January 2003 until July 2007.  He oversaw approximately $1.3 billion in assets.  He’s currently responsible for about half that amount.  He’s got about 30 years of experience and is, as I noted above, supported by the team from his former employer.  He’s a graduate of Kenyon College (a very fine liberal arts college in Ohio), the City College of New York (where he earned an architecture degree) and New York University (M.B.A. in finance).

Inception

December 27 2010.

Management’s Stake in the Fund

Mr. Walthausen has between $100,000 and $500,000 in this fund, over $1 million invested in his flagship fund and also owns the fund’s adviser.

Minimum investment

$2,500 for all accounts.  There’s also an “investor” share class with a $10,000 minimum and 1.46% expense ratio.

Expense ratio

1.70% on an asset base of about $1.2 million (as of 01/31/2011).

Comments

The case for Walthausen Select Value is Paradigm Value (PVFAX), Paradigm Select (PFSLX) and Walthausen Small Cap Value (WSCVX).   Mr. Walthausen is a seasoned small- and mid-cap investor, with 35 years of experience in the field.   From 1994 to 2007 he was a senior portfolio manager at Paradigm Capital.  He managed Paradigm Value from its inception until his departure, Paradigm Select Value from inception until his departure and Walthausen Small Cap Value from its inception until now.

Mr. Walthausen’s three funds have two things in common:  each holds a mix of small and mid-cap stocks and each has substantially outperformed its peers.

Walthausen Select parallels Paradigm Select.  Each has a substantial exposure to mid-cap stocks but remains overweight in small caps.  In his two years at Paradigm Select, Morningstar classified the portfolio as “small blend.”  Paradigm currently holds about one third of its assets in mid-caps while Walthausen Select is a bit higher, at 45% (as of 04/30/2011).  In each case, the stocks were almost-entirely domestic.  Walthausen Small Cap Value has about 85% small cap and 15% mid-cap, while Paradigm Value splits about 80/20.  In short, Mr. Walthausen is a small cap investor with substantial experience in mid-cap investing as well.

Each of Mr. Walthausen’s funds has substantially outperformed its peers under his watch.

Paradigm Select turned $10,000 invested at inception into $16,000 at his departure.  His average mid-blend peer would have returned $13,800.

Paradigm Value turned $10,000 invested at inception to $32,000 at his departure.  His average small-blend peer would have returned $21,400.  From inception until his departure, PVFAX earned 28.8% annually while its benchmark index (Russell 2000 Value) returned 18.9%.

Walthausen Small Cap Value turned $10,000 invested at inception to $14,000 (as of 08/2/2011).  His average small-value peer would have returned $10,400. Since inception, WSCVX has out-performed every Morningstar “analyst pick” in his peer group.  That includes Royce Special (RYSEX), Paradigm Value (PVFAX), Vanguard Tax-Managed Small Cap (VTMSX), Bogle Small Cap Growth (BOGLX), Third Avenue Small-Cap Value (TASCX) and Bridgeway Small-Cap Value (BRSVX).  WSCVX earned more than 40% in each of its first two full years.

Investors in Walthausen Select are betting that Mr. Walthausen’s success is not due to chance and that he’ll be able to parlay a more-flexible, more-focused portfolio in a top tier performer.   A number of other small cap managers (at Artisan, Fidelity, Royce and elsewhere) have handled the transition to “SMID-cap” investing without noticeable difficulty.  Mr. Walthausen reports that there’s a 40% overlap between the holdings of his two funds. There are only a few managers handling both focused and diversified portfolios (Nygren at Oakmark and Oakmark Select, most famously) so it’s hard to generalize about the effects of that change.

There are, of course, reasons for caution.  First, Mr. Walthausen’s other funds have been a bit volatile.  Investors here need to be looking for alpha (that is, high risk-adjusted returns), not downside protection.  Because it will remain fully-invested, there’s no prospect of sidestepping a serious market correction.  Second, this fund is more concentrated than any of his other charges.  It currently holds 42 stocks, against 80 in Small Cap Value and 65 in his last year at Paradigm Select.  Of necessity, a mistake with any one stock will have a greater effect on the fund’s returns.  At the same time, Mr. Walthausen believes that 75% of the stocks will represent “good, unexciting companies” and that it will hold fewer “special situation” or “deeply troubled” firms than does the small cap fund. And these stocks are more liquid than are small or micro-caps. All that should help moderate the risk.  Third, Mr. Walthausen, born in 1945, is likely in the later stages of his investing career.  Finally, the fund’s expenses are high which will be a major hassle in a market that’s not surging.

Bottom line

There’s considerable reason to give Walthausen Select careful consideration despite its slow start.   From inception through late August 2011, the fund has slightly underperformed a 60/40 blend of Morningstar’s small-core and midcap-core peer groups.   Mr. Walthausen’s track record is solid and he’s confident that this fund “will be better in a muddled market” than most.  While it’s more concentrated than his other portfolios, it’s concentrated in larger, more stable names.  Folks willing to deal with a bit of volatility in order to access Mr. Walthausen’s considerable skill at adding alpha should carefully track the evolution of this little fund.

Company link

Walthausen Funds homepage, which is a pretty durn Spartan spot but there’s a fair amount of information if you click on the tiny text links across the top.

© Mutual Fund Observer, 2011.  All rights reserved.  The information here reflects publicly available information current at the time of publication.  For reprint/e-rights contact [email protected].