Fund name: Croft Value (CLVFX)

Objective: They seek long-term growth with managed risk.  The managers describe themselves this way: “We seek to buy stocks at ‘80-cents-on-the-dollar’ and hold them for at least 3-5 years. We believe this offers our investors the potential for higher returns with lower risk. Reduced risk is inherent in our investment philosophy.”  The fund is flexible and will purchase stocks of different market caps (45% is currently in mid- to small-cap stocks), across a wide variety of style-boxes.  About 11% is invested overseas.

Adviser:  Croft-Leominster, a Baltimore-based manager “with a wealth of experience. The Croft-Leominster management team has over 100 years collective experience and national clientele.” The firm manages more than $600 million in separately managed portfolios as well as two funds, Value and Income.  There is a Castle Croft (“ a 17th century stone quadrangular manor house, built close to the site of the old medieval castle” according to the official Castle website for the UK) near Leominster (pronounced “Lemster”) in England.  The fact that not even the staff at the advisor can pronounce it correctly may explain why the Crofts are transitioning away from “Croft-Leominster Value” to “Croft Value.”

Manager:  Gordon, Kent, and Russell.  The senior Mr. Croft, Gordon, worked for T. Rowe Price from ’67-‘89 and was a director of the firm.  He co-founded Croft-Leominster in 1989 and has managed the fund since inception.  Kent Croft worked for Salomon Brothers before co-founding the advisor with his father.  He has also managed the fund since inception.  Russell Croft joined the team in 2006 after working a while for Gabelli Asset Management.

Management’s Stake in the Fund: The senior Mr. Croft has between $500,000 and a million in the Value Fund, each of the junior Messrs Croft have between $100,000 and 500,000.  In addition, the managers collectively own 71% of the fund’s advisor.

Opening date: May 4, 1995.

Minimum investment: $2000 for regular accounts, $500 for IRAs.  The fund is available for purchase in all states.

Expense ratio: 1.49% on assets of $23 million.  The expense ratio was reduced by two basis points on 10/1/07.

Comments: I don’t know whether, as is the case with many of the Stars in the Shadows, this mutual fund started out as a “friends and family” operation.  It certainly occupies a tiny niche at Croft-Leominster, and represents less than 4% of the firm’s assets under management.  That would usually signal that this was opened as a service to their existing clients, rather than as a stand-alone offering.

The managers articulate a sensible, unexceptional strategy:

Over a year's time, we may consider more than 1000 stock ideas. These originate from inside the firm or arrive through a variety of external experts and research firms. We have a staff of analysts and get stock ideas from other money managers we respect (our network of 'deep-thinkers'), independent research firms and Wall Street analysts.

·         We whittle these down to roughly 500 by looking for acceptable valuations. We use traditional valuation measures such as price-to-earnings ratios, but also look for strong cash flow, quality assets, and a potential for growth that are not reflected in current stock price.

·         We narrow the list to 200 stocks that we continuously monitor focusing on companies that offer:

1.     A catalyst for growth

2.     Growth at a reasonable price

3.     Contrarian plays

·         Our portfolio represents the 80 or so best ideas of the above.

As a result, the term “Value” in the fund name should be read as “relative value” in about the sense that Bill Miller uses in explaining why Legg Mason Value was buying Amazon and Google.  That relativism is borne out when we look at Croft Value’s portfolio.  By Morningstar’s calculation:

• 41% of the portfolio is invested in “growth” stocks
  
• 24% is invested in “value” stocks
  
• currently about half the portfolio is invested in energy and industrial materials
  
• with regard to market cap and valuations, Morningstar places the center of the fund’s portfolio exactly at the intersection of blend and growth and large and midcap.

The key seems to be good execution.  The managers have parlayed an unexceptional strategy into very exceptional performance:

• for most trailing time periods, the fund has posted top 10% sorts of returns. They’re top 2-4% for 2007 (through 10/31/07, for the trailing 12 months, three years and five years. For the past decade, they’re in the top 18% of large-blend funds.
  
• total returns have been around 20% for the trailing three- and five-year periods, and 7.5% for the past decaade.
  
• they’ve beaten the S&P 500 in every trailing time period that Morningstar follows.
  
• Lipper recognizes them as "Lipper Leaders” for both Total Return and Consistent Return.
  
• because of their low-turnover style (the latest estimate is 19%), the fund tends to be tax-efficient.

Despite risk-consciousness on the managers’ part, Morningstar ranks this as a “high risk – high return” fund, though the return has outweighed the risk by enough to earn it four- and five-star ratings from Morningstar.  The problem with such judgments is that Croft’s portfolio doesn’t track any index very closely, so comparisons that presuppose high correlations (for example, beta measures are reliable only when R-squared correlations are high) tend not be very helpful.  The fund’s beta is higher than the S&P’s (though the r-squared is just 69) and the beta is noticeably lower than the mid-cap average (though the r-squared is just 78). 

The fund had one bad year.  It lost almost 26% in 2002, about 3.5% worse than the S&P or its peers.  I’m not at all troubled by that single year’s performance, though I am perplexed by my inability to locate a shareholder report in which the managers explain it.  The annual reports are not available on the firm’s website and the reports filed with the SEC seem to skip over their relatively weak performance in the second half of the year.

Bottom Line: This is, on whole, a strong, sensible core fund.  Assets in the fund have quadrupled since 2003, but the asset base remains very modest and steady inflows should give the managers cash to deploy as the market offers up opportunities.

Fund website: http://www.croftleo.com/