Amy Zhang, manager of the Alger Small Cap Focus Fund, explained last April how she had improved the fund’s performance since taking over the portfolio in 2015. She hasn’t lost her touch since that conversation.
Here’s a link to the April 2018 interview in which Zhang explained her stock-selection process in detail. Since April 11, the day before that interview was published, the Alger Small Cap Focus Fund’s class A shares
have returned 19%, while the Russell 2000 Growth Index
has declined 1.6%. (During that same period, the Dow Jones Industrial Average
has returned 3.8% and the S&P 500 Index
has returned 4.2%).
At the time of the first interview, the fund had $804 million in assets and a four-star rating from Morningstar for its class A shares. Since then, the fund has more than tripled to $2.7 billion in assets and now has a five-star rating (the highest) from Morningstar for class A.
That is remarkable, especially when you consider how painful the fourth-quarter price action was. During a follow-up interview last week, Zhang said: “The most important thing is letting the market serve us, use volatility as our friend and focus on risk/reward.”
As new money continued to pour into the fund, she would increase positions she felt represented the best value at that time, based on volatile price action.
“We do a lot of stress tests,” she said. “Having a solid bear price, when assumptions are so low/pessimistic — that is what I call a margin for safety. Understanding when to buy serves me very well. Buying low always works.”
She said that for three years, through Dec. 31, the fund captured 122% of the benchmark Russell 2000 Growth Index’s upside movement, while capturing only 80% of the downside.
Zhang described a successful investment in Apptio, which was acquired by Vista Equity Partners in January. The Alger Small Cap Focus Fund began buying shares of Apptio in November 2017, when they were trading around $22. Zhang said she was attracted to the company because it was a developer of technology business management (TBM) software used to “automate and optimize IT budgets.”
Annual revenue was about $200 million when Zhang decided to begin buying shares, and she expected it to double in the next three to five years, in part because the company “was executing well and expanding into government.”
“For me there is a lot of pattern recognition. I like to see companies that are already dominant, but then expanding into another large market, which is probably even stickier,” she said.
So Apptio was among the fund’s top holdings in the third and fourth quarters of 2018. But Apptio disappointed investors with third-quarter sales coming in below expectations, which Zhang wasn’t concerned about, because “it was a result of a change in the billing terms, not really a fundamental weakness.”
So Zhang was buying on weakness, in the $23 to $24 range late in October, before Vista’s deal taking out Apptio at $38 a share was announced Nov. 11.
“That was a great example of using volatility as our friend and not to let the market action dictate my behavior,” she said.
was the second-largest holding of the Alger Small Cap Focus Fund as of Dec. 31. The company provides diagnostic testing for heart-transplant patients, and has more recently moved into testing for kidney transplants, with the goal of preventing organ rejection.
The company’s AlloSure tests are noninvasive and detect fragmented DNA to determine if a transplanted kidney has suffered a graft injury, to monitor a patient for possible reject of the organ.
Zhang said she began buying shares of CareDX late in 2017 after the company had reached an “inflection point.” This was the beginning of Medicare reimbursements for AlloSure, which were effective as of Oct. 9, 2017. “We invested after that because Medicare covers 80% of kidney-transplant costs, regardless of the age of the patient,” she said.
“I was confident they were in the process of cleaning up their balance sheet. Fast forward, they become debt-free in 2018. That is a transformation,” Zhang said. She estimates that kidney-transplant-rejection testing is a “$2.7 billion-plus total addressable [annual] market.” CareDX estimated that its 2018 sales totaled between $76.2 million and $76.5 million.
“So there is a large runway for growth — they are definitely the market leader,” Zhang said, especially because CareDX is the only company receiving Medicare reimbursement for kidney-transplant testing.
was the largest holding of the Alger Small Cap Focus Fund when we interviewed Zhang in April, and it was the fund’s sixth-largest holding as of Dec. 31.
Zhang first bought shares of Veeva in 2015 on the strength of its Vault content-management software for the life-sciences industry, which she says has been growing as expected, while the company’s traditional CRM [customer relationship management] software acts as “a cash cow.”
“In calendar year 2015, Vault was 22% of Veeva’s total revenue. Now it is 45% of total revenue. They are still growing over 50% [a year] so there is a very positive product mix,” she said.
Meanwhile, Veeva’s gross margin (sales, less the cost of goods sold, divided by sales) has continued to expand, Zhang said. [According to FactSet, the company’s gross margin for the most recently reported quarter was 72.7%, expanding from 69.9% a year earlier.] One reason for the company’s overall margin expansion is that Vault has a higher margin than Veeva’s traditional CRM software, “which requires a sales force,” she said.
“We still think Vault is at an early stage of growth,” Zhang said, in part because Veeva is expanding it beyond the life-sciences industry, as it can be used for “any regulated content solution.” These might include consumer-packaged goods, chemicals, cosmetics and industrials/manufacturing, she said.
Looking ahead, Veeva expects to roll out Vault Safety this year to replace legacy systems, including those used in the pharmaceutical industry, and two more software products: Nitro, a commercial cloud application meant to help life-sciences companies meld incompatible data from legacy systems, and Andi, which will use artificial intelligence (AI) to help manage sales teams.
“Veeva is an extremely innovative company that spends a lot on R&D. On top of that, they still have the highest GAAP operating margin of all SaaS [software as a service] companies,” Zhang said.
Here are the top nine holdings of the Alger Small Cap Focus Fund (leaving out Apptio, which was acquired in January), as of Dec. 31:
|Company||Ticker||Share of portfolio||Total return – 2019||Total return – 2018|
|Tandem Diabetes Care Inc.||4.4%||11%||1,509%|
|Cantel Medical Corp.||3.5%||8%||-28%|
|Veeva Systems Inc. Class A||3.3%||29%||62%|
|Shopify Inc. Class A||2.7%||27%||37%|
|Medidata Solutions Inc.||2.7%||9%||6%|
|Sources: Alger, FactSet|
The Alger Small Cap Focus Fund has five share classes, most of which are distributed through brokers and investment advisers. Minimum investment amounts among share classes can change, depending on the relationship between your broker or adviser and Alger. The class A shares have a 5.25% sales charge but the sales charges can be reduced depending on the amount of money you invest. The Class C shares have a 1% deferred sales charge on shares that are sold.
It is important to look into all the fees, charges and account minimums for every share class when considering an investment. You can find this information about any mutual fund in its prospectus and if you are working with an adviser, take the adviser’s own fees into consideration.
Here are the annual expense ratios for each share class of the Alger Small Cap Focus Fund:
|Fund share class||Ticker||Annual expense ratio||Basic initial account minimum|
Some expenses are waived for extended periods but the waivers can end.
Here’s how the five share classes have performed against the Russell 2000 Growth Index and the fund’s Morningstar category. The performance figures are net of expenses but exclude sales charges. They also don’t reflect any additional annual fees you pay your adviser:
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