Are Fund Reopenings Contrarian Buy Signals?

During 2008's gloomy market, approximately 90 distinct mutual funds reopened their doors because their asset bases dwindled or the fund managers wanted the extra cash to go bargain-hunting. In March we highlighted an eclectic group of reopened funds that were worth considering. Despite the negative sentiment pervading the market at the time, that turned out to be a good time to invest in equity funds. The past week notwithstanding, the broad stock market has leapt by about 50% since early March. Many funds that threw open their doors in the midst of 2008's turmoil have rallied, too. Here we take a closer look at the performance of small-cap funds that reopened in 2008.

Reopening Low, Heading Higher
Nearly 30 domestic small-cap funds reopened in 2008, and most of them have soared past their peers during the rally that began on March 9, 2009. About half landed in the top third of their respective categories for the year to date ended Aug. 31, 2009. The top 10 performers are in the table.

All these funds lagged their peers last year but land near the top of their respective categories so far this year and since the March 9, 2009, market bottom. The funds' gains from March 9 to Aug. 31 ranged from 58% for both  Wasatch Ultra Growth (WAMCX) and  Wasatch Small Cap Growth (WAAEX) to 112% for  Schneider Small Cap Value , one of the funds we highlighted in March.

Three micro-cap-focused funds made the top 10 because when panic gripped the markets last year, investors dumped micro-caps en masse. Since these tiny firms often have weaker financial positions and lack diversity in their revenue streams, they get hit hard as the economy slows and revenues slump. But the fortunes of these budding businesses can also turn quickly, and micro-cap-heavy  Royce Opportunity (RYOFX),  Buffalo Micro Cap (BUFOX), and  Wasatch Micro Cap (WMICX) have snapped back by 111%, 85%, and 67%, respectively, since the last bottom. In addition, funds with more than 10% in foreign small-cap stocks, including this handful of Wasatch funds and  Royce Low Priced Stock , also hit the top 10. (The foreign small/mid-cap equity categories are up twice as much as their domestic counterparts in 2009.)

All of these funds were poised to rebound simply because they invest in smaller, economically sensitive companies, but they also reopened at a time that allowed their managers to do bargain-hunting with new cash.

Data as of 8-31-2009.

How Reopened Funds Recharged
Royce Low Priced Stock reopened in January 2008, and by midyear, manager Whitney George had been aggressively buying technology stocks. Late in the year, George turned to two of the most decimated areas of the market--energy and agriculture-related stocks. He added to multiyear favorites such as Ensign Energy Industries and Unit Corporation  and picked up new names such as  Terra Industries (TRA) and  Intrepid Potash (IPI). This fund had a roughly 12% cash stake coming into the fourth quarter, but George's bargain-hunting whittled that down to 1% during two of the worst months of the downturn.

The managers of  William Blair Small Cap Growth (WBSNX) focused on companies they knew well. Michael Balkin and Karl Brewer added to printing company VistaPrint (VPRT), a top holding that's up 113% this year. They also dove back into  ValueClick  in January 2009, which they had previously owned until 2007, because it looked cheap given its cash-rich balance sheet and position as an Internet advertising industry leader. The stock has jumped roughly 50% since they bought it.

Arnie Schneider of Schneider Small Cap Value  bolstered some larger and badly beaten technology and energy holdings late last year and during the first quarter of 2009. These include semiconductor and semi equipment firms  Entegris (ENTG) and  Lam Research (LRCX), up 75% and 42%, respectively, this year. But not all of his bargain-hunting has paid off yet. Schneider ratcheted up the fund's exposure to firms that stand to benefit from a supply/demand imbalance for natural gas, such as  Forest Oil Corporation . The stock is down 6% this year, but he expects the position to pay off in 2010.

Not everyone went on a buying spree. Buffalo Micro Cap's (BUFOX) manager, Grant Sarris, stood pat. He maintained the fund's hefty stake in consumer goods firms in part by sticking with beaten-up stocks such as McCormick & Schmicks Seafood  and Oxford Industries (OXM), which fell about 60% last year. Those stocks are up 126% and 58%, respectively, so far this year.

Fortune Favors the Prepared
In this case, holding your nose and jumping into these funds when they reopened started to pay off quickly. That won't happen every time a fund reopens. You also probably shouldn't expect these funds' torrid performances to continue unabated. Morningstar still thinks all of the funds listed above are good long-term bets, but stocks, particularly small-cap issues, have risen breathtakingly fast in this spring and summer's rally. Some sort of pause or correction is possible, so investors should keep their short-term expectations in check.

Nevertheless, fortune can favor those who are ready to pounce when solid, closed funds become available.