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Seeing Is Believing

The team at the small-cap shop SouthernSun relies more on their senses than a computer to understand companies.

Michael Brennan, 04/08/2013

It was early 2009. Members of the Memphisbased SouthernSun Asset Management team were in Virginia doing a site visit at Smithfield Foods SFD, the meat-products company in which SouthernSun Small Cap Investor SSSFX had been invested for six years. The SouthernSun team was not helicopter-parenting Smithfield; that’s not the firm’s style. The team was simply swinging by to make sure everything was copacetic at a firm accounting for between 4% and 6% of SouthernSun Small Cap’s assets.

SouthernSun founder, CEO, and CIO Michael Cook, 56, had made the trip, as had his son, 31-year-old senior analyst Phillip Cook. Members of Smithfield’s leadership team were escorting the Cooks through the company’s state-of-the art plant and stopped to show off the gleaming, monolithic visage of Smithfield’s heavy investment in high-efficiency, high-volume packing machinery. The Smithfield executive sang the machine’s praises, explained what it would do for his company’s production and distribution economics, and generally sold the SouthernSun managers on the merits of that particular investment.

The visit ended with two outcomes. First, Smithfield was, anticlimactically, awarded a thumbs-up from the Cooks. (SouthernSun had already established a strong track record of success, so it was little surprise that one of the firm’s bets was paying off.) Second, the Cooks left wanting to know more about the company making industrial-level foodprocessing machinery so wondrous that its customers went out of their way to tell stories about it. That particular machinery, it turned out, was manufactured by Middleby MIDD. It is highly regarded across the industry and has few competitors.

If you worked for SouthernSun, you liked what you saw before you even got into Middleby’s finances. So naturally, the Cooks figured they might be on to something, and they set about doing their homework on Middleby. Everything checked out, and by August 2009, the company was in Small Cap’s portfolio.

Within three years its share price had jumped nearly 50%. In the years since, the Cooks and their colleagues have made their share of site visits to Middleby—just to see what they can see.

From Zero to $500 Million in 10 Years
That’s pretty much the method SouthernSun’s managers have followed in increasing Small Cap’s assets from less than $700,000 when the fund launched in 2003, to more than $13 million a year later, to more than $60 million by 2007, to more than $200 million in 2011, to just over $500 million today. While those figures include the natural jump resulting from the October 2009 launch of the Small Cap Institutional share class, it’s been a breathtaking trajectory by any standard. And it’s mostly been accomplished, the team says, with an investment approach that combines bottom-up research, awareness of the macroeconomic environment, and when a prospect meets their criteria, betting big.

“We very rarely use quantitative screens,” says Phillip Cook of his 26-member firm. “We do our own work. We visit companies; we visit management; we visit their facilities; we visit their suppliers. We go to industry trade shows more frequently than sell-side, Wall Street investor conferences.”

Small Cap bested both the S&P 500 and Morningstar’s small-blend category in seven of the nine full calendar years since its inception and is ahead of both so far this year. As of Feb. 24, the fund is sitting on five-year annualized returns of 12.55%, compared with the S&P 500’s and the category’s respective returns of 4.61% and 6.42%.

Michael Brennan is a copy editor with the Morningstar Fund Research Team.

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