Deep Dive: Want an insider’s way to play IPOs? This fund has had outsize success with its strategy
With thousands of actively managed mutual funds to choose from, it’s as difficult to be distinguished from the crowd as it is to beat the broad stock-market indexes. But the Federated Kaufmann Small Cap Fund has done both.
In an interview, John Ettinger, one of the fund’s managers, described the Kaufmann team’s specialty — analyzing and participating in initial public offerings (IPOs), and often holding those positions for long periods. About half of the fund’s 179 stock positions as of Feb. 28 originated when the shares were first offered to the public.
The Kaufmann Funds are part of the Federated Investors FII, +1.43% group, which includes several fund families. The Kaufmann team is based in New York and manages about $ 12.4 billion, including $ 2.4 billion in the Federated Kaufmann Small Cap Fund FKASX, +0.20% The fund has trounced the performance of its benchmark, the Russell 2000 Growth Index RUO, +0.18% as well as many other indexes and its Morningstar category, as you can see at the bottom of this article.
Specializing in companies that go public
“We evaluate almost every IPO that comes to market,” Ettinger said, which includes meeting with management teams and visiting companies’ facilities. He said the Kaufmann team had an advantage when evaluating “the next generation of great growth companies,” not only because of long experience in this area, but because they “have great relationships with the investment banks.”
Investors often think of IPO shares as hot commodities and worry about missing out if they are unable to participate at the initial offering price. That can cause a large day-one gain for the share price, as we saw when Lyft LYFT, -1.83% went public March 29. The IPO had been priced at $ 72. The shares rose as high as $ 88.60 on the first day of trading, before closing at $ 78.29. The shares on Friday were trading at around $ 59.
Ettinger said the best investments among IPOs are often those that fly under the radar.
“A lot of times we will make a lot of money in a cold deal,” he said. “We can take down a lot of stock and be more involved in the pricing of that deal. You are not going to get that initial pop on day one, but if we have a million shares and it doubles in two years, we are going to make a lot more money than we would if it popped on day one.”
Examples of long-term IPO investments
“My first IPO recommendation in 1998 is still in the fund,” Ettinger said. That is CoStar Group CSGP, +1.20% which went public at $ 9 a share in July 1998 and closed at $ 478.67 on April 10. Ettinger said the Kaufmann team will often trade around positions after making an initial purchase at IPO. But in the case of CoStar, the Federated Kaufmann Small Cap Fund still holds the block of 100,000 shares it bought when the company went public.
CoStar provides information to commercial real estate brokers, lenders, appraisers and owners in the U.S. and U.K. “They have also become a leader in the multifamily space, selling information and providing tenant leads to landlords who are looking to fill their apartment buildings,” Ettinger said.
The company has a market capitalization of $ 17.6 billion, which is rather large for a fund with “small cap” in its name. “We don’t sell successful companies,” Ettinger said. “Some of our competitors may have to sell a position based on market cap. We won’t sell a company that is executing just because it has become a mid-cap company. We will hold our winners a long time.”
When asked if he believed CoStar would still be a good investment for someone going in now, he said: “I have held it 20 years and will probably be holding it another 20.”
Another holding of the fund that began at IPO is Americold Realty Trust COLD, -0.13% which Ettinger described as “the only publicly traded REIT specializing in temperature-controlled warehouses.” The company went public in January 2018 at $ 16 a share. The stock closed at $ 31.08 on April 10.
When the Kaufmann team was evaluating Americold, Kaufmann visited one of its warehouses in Atlanta. “This is a very complicated mission-critical business,” he said. “They are the leaders here. They are bringing a lot of technology and automation to an area that historically has had little of it.”
He said Americold is the “best-in-class operator,” and it will be able to consolidate a “very fragmented” industry.
Another fascinating name Ettinger described is ShotSpotter SSTI, +1.85% which he said was “a very small IPO” that came to market at $ 11 a share in June 2017. The stock closed at $ 31.08 on April 10. The company supplies gunshot-detection systems to cities.
“Eighty percent of gunshots result in no 911 call,” Ettinger said, underlining the importance of ShotSpotter’s service. “They have sensors to identify whenever a shot is fired in a particular area so police can respond to all the gunshots, instead of one out of five. This builds a lot more trust with the community.”
The system works with GPS to help police officers pinpoint precisely where a shot was fired, where they often find shell casings or other evidence. The detection system can help police find out how many shooters are involved and what types of guns are used.
“I went to the International Association of Chiefs of Police conference and spoke to at least a dozen police chiefs using the product. They were all singing its praises and how much it has helped them and how this product should really be the standard of any city that has gun violence,” Ettinger said.
ShotSpotter is providing service to about 100 cities. Ettinger called the company “far and away the leader” in its space and said it has “a lot of runway for growth.”
The last example Ettinger named was Planet Fitness PLNT, +0.39% which went public at an initial price of $ 16 in August 2015. The stock closed at $ 70.76 on April 10.
Planet Fitness ended 2018 with 1,742 stores, with all but 76 franchised. The company opened 230 stores last year, 226 of which were franchised, and it expects to maintain a similar growth pace.
What sets the company apart from other gym operators, according to Ettinger, is “their competition is not other gyms, it is the couch.” He said similar words were used by senior managers of Planet Fitness when he met with them.
“About half of their new customers have never belonged to a gym before,” he said.
He likes the franchise model because it requires “little capital expenditure” for Planet Fitness to expand and increase its revenue. “They have the top brand in the industry, and they spend a good deal on marketing to maintain that brand leadership and awareness,” he said.
Ettinger said franchisees are generally happy and that many would like to open more Planet Fitness gyms near the ones they are operating. He believes the company can expand its U.S. presence to over 4,000 gyms.
The Federated Kaufmann Small Cap Fund held 179 stocks as of Feb. 28. This is not a concentrated strategy, so a list of the top holdings may not be especially meaningful — they are top holdings in part because of stellar recent performance. Still, here are the top 10 holdings of the fund (actually 11, because American depositary receipts of Argenx SE were the top holding, while the company’s shares are listed on the Euronext Brussels exchange):
|Ticker||Share of fund||2019 through April 10||2018||3 years|
|Argenx SE ADR||ARGX, +0.60%||2.1%||33%||52%||N/A|
|Spark Therapeutics Inc.||ONCE, -0.55%||1.7%||188%||-24%||235%|
|Argenx SE||ARGX, +1.16%||1.6%||32%||62%||977%|
|Veeva Systems Inc Class A||VEEV, -0.55%||1.3%||52%||62%||433%|
|Rapid7 Inc.||RPD, +0.11%||1.2%||70%||67%||317%|
|Ultragenyx Pharmaceutical Inc.||RARE, +1.90%||1.2%||68%||-6%||4%|
|Alteryx Inc. Class A||AYX, +1.94%||1.1%||37%||135%||N/A|
|Inspire Medical Systems Inc.||INSP, +3.83%||1.1%||32%||N/A||N/A|
|Planet Fitness Inc. Class A||PLNT, +0.39%||1.0%||32%||55%||439%|
|UniQure NV||QURE, -0.22%||1.0%||102%||47%||326%|
|Sources: Federated Investors, FactSet|
Veeva Systems VEEV, -0.55% is a particular favorite of Amy Zhang, manager of the Alger Small Cap Focus Fund AOFAX, -0.55% who talked about the company in February.
The Federated Kaufmann Small Cap Index Fund has six share classes with different expenses. The institutional shares technically have a sales charge of 5.50%. However, sales charges may be waived depending on the relationship between your broker or financial adviser with Federated Investors. The total return figures shown below are net of expenses but exclude any sales charges.
The benchmark for the fund is the Russell 2000 Growth Index RUT, +0.36% Returns for the S&P 600 Small-Cap Index, the S&P 400 Mid-Cap Index MID, +0.76% and the S&P 500 Index SPX, +0.66% are shown for comparison, along with those of the fund’s Morningstar category.
|Total return – 2019 through April 10||Average annual return – 3 years||Average annual return – 5 years||Average annual return – 10 years||Average annual return – 15 years|
|Federated Kaufmann Small Cap Stock Fund – Institutional FKASX, +0.20%||24.8%||29.3%||17.1%||19.1%||11.2%|
|Morningstar Small Growth category||18.1%||16.6%||9.0%||15.4%||8.6%|
|Russell 2000 Growth Index RUO, +0.18%||20.0%||16.1%||10.0%||15.7%||8.7%|
|S&P 600 Small-Cap Index SML, +0.43%||15.0%||14.5%||9.8%||16.1%||9.7%|
|S&P 400 Mid-Cap Index MID, +0.76%||17.5%||12.7%||9.5%||15.5%||9.6%|
|S&P 500 Index SPX, +0.66%||15.9%||14.5%||11.8%||15.3%||8.6%|
|Sources: Morningstar Direct, FactSet|
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