A Small-Cap Fund's Winning Discipline

A Small-Cap Fund's Winning Discipline

Compass follows a high-growth path

Sandra Ward

If Topps issued a card series for

mutual-fund managers, no set would be complete without a

William J. Wykle. As manager of Compass Small Cap Growth

Fund, the 59-year-old Wykle has compiled some compelling

stats. The fund ranked among the top 10 in its category in

the third quarter and in the past year and in the past three years (1993 was the rookie year for the retail fund),

delivering cumulative returns of 5.26%, 45.14% and 108.30,

respectively. Consider that the average small-cap fund

returned 1.76% in the quarter, 18.40% in the one-year period

and 54.65% in the three-year time frame and you'll

understand the magnitude of the achievement.

There's no contest, either, when you compare Compass with

general equity funds. The average general equity fund gained

2.61% in the quarter, 16.90% in the year ended Sept. 30 and

50% in the three years.

A good eye and a disciplined investment strategy has

resulted in an outstanding and consistent track record,

which recently earned Compass Small Cap a five-star rating

from fund evaluator Morningstar. Compass, with $520 million

under management, is the former PNC Small Cap Growth Fund

and a part of the asset-management arm of PNC Bank.

Wykle concentrates on those companies with market

capitalizations of between $100 million and $1 billion that

generate earnings growth of 20% or more and display equally

strong technical characteristics, so-called relative

strength or share-price momentum. Indeed, the average rate

of earnings growth for the Compass portfolio of 125 to 130

names in 1997 is estimated at 39%.

``We're fishing in ponds where the fish are rapidly

growing,'' Wykle explains in the lush, friendly tones that

give away his West Virginia roots and reveal his love of the

outdoors. (The colorful duck cufflinks peeking out from

beneath his suit sleeves betray his real passion: duck

hunting.)

Once he's netted the fast growers, he then studies their

balance sheets and income statements to determine how well

they're run and the likelihood that they'll sustain the

heady pace of growth. Next, he interviews management to see

if it can articulate a strategy and a vision ``to take the

company to the next level.'' And he limits the research to

three sectors: technology, health care and consumer

services. The Russell 2000 Index is used strictly as a

benchmark for performance, not as a means of picking stocks

and weighting sectors.

Stocks are added to the portfolio in equal measure, so that

they represent 0.5% of the portfolio. Wykle stops buying a

stock when it reaches 1%-1.5% of the total. If a holding

reaches 3% of the portfolio through appreciation and

rebalancing, he trims the name automatically.

``We don't want any one stock having a negative impact on

the portfolio,'' he explains.

And he practices an uncompromising sell discipline, a task

he ranks as the ``most important thing to address'' in

portfolio management.

``If a company fails to meet earnings expectations, it is

sold,'' says Wykle firmly. Also, news that could portend

earnings problems will force a sale, as will signs of

fundamental problems. And any deterioration in ``relative

strength'' is reason to purge a name. The policy is

unforgiving.

Compass, for example, recently purchased shares of Riscorp,

which provides workers' compensation services to

corporations, mostly in Florida, when that state's insurance

commissioner proposed cutting reimbursement rates for

workers' compensation. Compass immediately turned around and

sold Risc, now a risk.

``You get blindsided,'' says Wykle.

But that kind of attention to discipline and fundamentals

saved Compass after July's correction: ``We came roaring

right back,'' Wykle points out, after being down more than

10%.

Wykle and his team of an assistant manager and three sector

analysts meet each Monday to review the holdings in the

portfolio. Yet, for a small-cap fund with strict sell

criteria, the portfolio has a surprisingly low turnover

rate: 81%.

And Wykle has plenty of new ideas.

Brand new to Compass is Saville Systems PLC, based in

Ireland, a designer of customized billing software for

telecommunications providers. It went public at 10 last

November, and recently changed hands at about 43. Wykle

started buying in the past six weeks, lured by earnings

growth prospects of 35%-40% a year and the potential to

sustain that kind of growth in a climate of deregulation.

Because Saville also provides customer service, Wykle sees

it as an attractive play on corporate outsourcing. The

company, which has U.S. offices in Burlington, Mass, and

which does most of its business in this country, trades on

Nasdaq.

Wykle is also a big fan of Southern Energy Homes, a

mobile-home maker based in Alabama. Compass owns 4% of it

and has enlarged its position recently as the shares were

buffeted by concerns about a venture in Germany. Wykle likes the steady 20% earnings growth - pointing out that

manufactured homes represent 30% of all new housing in the

U.S. and 40%-45% in the South - and the fact that Southern

Energy not only makes the homes, but sells them, finances

them and insures them. While the firm has stumbled in

Germany, Wykle believes nonetheless that Europe offers

``tremendous'' opportunities for the manufactured housing

market.

Another recent addition to the portfolio is CBT Group PLC, a maker of interactive software tutorial products for high-end applications. Based in Ireland, it is growing at roughly 40% a year. The company went public at 20 a share in April of 1995 and traded recently at 47 3/4, adjusted for a 2-for-1 split in May.

Nice pitches all. But it's knowing when to swing at them

that has made Compass Small Cap Growth a winner.

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