Westwood is pleased to announce that Chris MacDonald has been promoted to Portfolio Manager of the Westwood SmallCap product and the Gabelli Westwood SmallCap Equity Fund.  Chris has worked on the product since its inception in 1994.  Below are his thoughts about the smallcap product and the market over the next three years. 

The next three years in the small cap market will be very exciting.  We believe the coming years could be similar to the period in the early 90's, when the economy came out of a recession and the small cap market performed very well.  Our process and results over the last 8 years demonstrates that a disciplined investment strategy can benefit our clients in both up and down markets.  This disciplined approach should continue to serve our clients well in the future. 

Since the inception of the Westwood SmallCap growth product, we have stressed a consistent, well-diversified approach in order to capture the best ideas in all areas of the economy.  We have sought dynamic companies across all sectors that are growing earnings faster than the index average, have low debt, high returns on equity, and whose sales and earnings growth rates are accelerating.  We have seen two different phases of market activity since 1994, and the Westwood SmallCap process has been able to outperform in both. 

The first phase, which began toward the end of 1994 and continued through March 2000, was characterized by a very strong economy, highly available capital for business creation and expansion, and of course, a booming stock market.  The technology stock bubble and the proliferation of day and individual traders only served to exacerbate the heights and overvaluation of the markets.  Growth stocks greatly outperformed value stocks in this era and Westwood SmallCap fully participated in the upsurge of the market.  Westwood SmallCap outperformed the Russell 2000 Growth Index over this period, returning on average 30.3% per year vs. the index return of 18.9% per year.  (see accompanying chart) As we all know, this period did not end well for investors due to the rampant speculation and the overvaluation of many stocks at the end of the era.   

Westwood greatly outperformed in the first phase. We were also able to outperform the index during the second, more trying phase of the market, which began in March 2000 and continued through the third quarter of 2002.  As part of our process for identifying companies with accelerating earnings growth, we steadily reduced our exposure to the higher valuation technology and capital goods stocks that had seen the strongest growth during the previous phase.  This benefited our performance during a very difficult period.  We reduced our technology exposure from 30.3% in 2000, to an average of 13.9% in the last half of the period.  We were also helped by our consistent goal to be a well-diversified growth manager.  We saw superior returns move to many other sectors of the market during this period, and as the less economically sensitive healthcare and consumer staples stocks outperformed, we were positioned to benefit from their strength.  While returns were negative during this phase, we outperformed the index, returning (25.5)% per year vs. the index at (29.5)% per year. 

The second phase has been extremely frustrating for all growth managers.  But, after almost two years of underperformance, strength in the growth area of the market returned in the late summer of 2002.  We are very excited about what we see as the next phase for the market.  We believe that we will see an overall economic recovery leading to higher corporate profits and higher stock prices.  While we see stocks overall performing well for the next three years, we are certainly expecting returns that are somewhat less spectacular than those in the first phase.  With hindsight, those stellar returns of the late 1990’s only set up the market for a spectacular fall, so another highly volatile, speculative era would certainly be unhealthy for the market and would be most unwelcome.  With more consistent, but muted, returns during the next era, a manager with a diversified portfolio and a consistent, disciplined investment process, who has proven to be an above average stock picker can thrive.  We feel the market will rise during the next phase, but the period will also separate the managers who only excelled in one era from those that have steered their ship through both periods with consistently good results.  We are confident that we can navigate our small cap clients through the next market stage with consistent results.