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June 30, 2002

Big Gains in Small Investing

By Tom Taulli

Benson Associates, a small-cap firm with only some $850 million in assets, can't measure up to the financial giants. Yet, in the world of small-caps - a world in which a 10,000 share trade is a big transaction - the Portland, Oregon firm is a giant.

The founder of the firm, Dale Benson, has over 30 years in the business and an excellent track record. Benson's recent 10-year record was an annual 18 percent return.

While small-caps can mean strong growth for a portfolio - especially if one picks the next Microsoft - it can also mean ultra-high risk. That's why Benson has a strong investment discipline, which is a bottom-up approach that relies on the fundamentals. The firm believes that there are many great companies that are basically undiscovered yet have great growth prospects.

Trading Desk

Another important element for Benson Associates is its trading, which is led by head trader Mike McDougall. The department has two traders. Prior to joining Benson Associates in 1997, McDougall worked as an assistant securities trader at Qualivest Mutual Funds, which is part of U.S. Bancorp Piper Jaffray.

McDougall focuses on stocks that typically have market caps of between $125 million and $250 million, with a breakdown of 35 percent listed securities and the rest Nasdaq securities. "I attribute this higher than expected listed percentage to mergers from our small market niche companies being gobbled by the big boys wanting to get into a particular market segment," McDougall said. "Also some of our small-cap stocks look to the day when they can say they trade on the Big Board."

Nevertheless, McDougall does not delve into OTC Bulletin Board or Pink Sheet stocks. Simply put, there is too much risk because most of these companies have little if any revenues and only one product, he contends. Besides, the liquidity can be terrible.

In fact, the concept of "liquidity" is a constant for McDougall. Building a position in a small-cap stock is no easy feat, as a few blocks can drive up the price. "The costs are higher than if I ran a big cap fund," McDougall said. "As a rule of thumb, expect a 10 percent haircut to get into the [small-cap] stock and a 10 percent haircut to get out."

The fund responds by focusing mostly on out-of-favor issues. "When investors are dumping the stock," McDougall said, "it gives us an opportunity to get a position, so long as the company meets our fundamental requirements."

It also helps that the fund takes a long-term approach to its holdings. "We are not quick traders," McDougall said. "We hold on to a stock for several years."

At times, the small-cap market can be a strange place. If a positive news report comes out, a company's stock may not move much. Does this mean the market is inefficient? Not necessarily, according to McDougall. Rather, with small-cap stocks, there may be mostly long-term shareholders. But as more news comes out, the stock price should rise as new investors come in.

In all, the portfolio of Benson Associates has about 145 stocks on average. McDougall may place about 30 to 40 trades per week. In building a position in a stock, it can often take a week. For now, McDougall works on a net basis on his trades. Still, he is on the fence on what approach is the best. "The net approach is working for us," McDougall said. "Of course, because of our low turnover, we do not generate huge commissions."

Building relationships is critical to all traders, including McDougall. Moreover, when placing trades, he does not discriminate. "To get the job done," he said, "we will use big brokers or small brokers or an ECN."