FBR Small Cap reopens to investors. But some of its holdings may surprise you. By David Landis, Contributing Editor March 31, 2007 Looking for a good small-company fund can be frustrating. The best tend to shut their doors rather than contend with more cash than they can invest easily. Chuck Akre, manager of FBR Small Cap, faced just such a situation in 2004. After a fabulous four-year run that produced annualized returns of 27%, the fund's assets had swelled to more than $1 billion. Saddled with $350 million in cash and no ready places to invest it, he put out the No Vacancy sign. Now that cash is down to about 8% of the fund's assets, FBR has reopened its doors, giving investors a rare second shot at a top-performing small-company fund. Among funds that invest mainly in fast-growing small companies, FBR ranked in the top 10% four times in the past six years, and it's a top performer over the past year. Over the past ten years to February 1, the fund (symbol FBRVX; 888-888-0025) returned 18% annualized, beating its peers by an average of ten percentage points per year. RELATED STORIES A Star of the '90s Rebounds Latest Fund Coverage The Seven Best New Funds Reluctant to sell In truth, FBR Small Cap isn't as small-company-oriented as its name suggests. Akre can invest in stocks with market values up to $3 billion. Half the stocks in his portfolio have market capitalizations of $1.5 billion or less, but many of his holdings are much bigger because of price appreciation (American Tower, for instance, has a market value of $17 billion). Akre is loath to unload a stock as long as it meets his two main criteria: return on equity (a measurement of profitability) "well north of 15%" and shareholder-friendly executives. As these companies reinvest profits in their businesses at high rates of return, they become "compounding machines," says Akre. Companies such as American Tower "continue to compound our capital, so we want to keep them." Akre holds down the fund's risk level by investing only in stocks that sell at a deep discount to his estimate of their true value. He looks for stocks that sell for no more than 15 times the ratio of price to free cash flow (the amount of cash generated each year minus the capital expenditures necessary to maintain the business). Advertisement The fund's turnover is remarkably low (3% in 2006), and it has managed to achieve its impressive returns with relatively little volatility (about 15% less than the average small-company growth fund). But FBR owns only about 40 stocks, and the top four holdings make up more than 40% of assets, adding to its risk. The concentration could backfire if the sectors Akre favors (gambling, property-and-casualty insurance and specialty retailing) all go south at once. An avid fox hunter, Akre runs the fund from the town of Middleburg, in Virginia's horse country. Practicing the shareholder-friendliness he preaches, Akre has more than $1 million of his own money in the fund and says his adult children are investors as well. Akre says there's no one signal that would indicate it was time to close the fund again. "I'll put on the brakes when I have difficulty putting the money to work," he says. FBR favorites: Small and not-so-small Penn National Gaming (symbol PENN) is among several gambling stocks that Chuck Akre began buying when they were trading at five to seven times free cash flow. Now they trade for nine times free cash flow. "I'm less concerned with the price once I own a stock," he says, as long as return on equity stays strong. Advertisement With a market value of $6 billion, CarMax (KMX) has outgrown its small-company status. But Akre is holding on because return on equity is 20%, and he thinks the used-car chain's popular, no-haggle sales model will propel growth well beyond its current 74 outlets. Berkshire Hathaway (BRK.B), valued at $168 billion, isn't exactly small, either. And its current return on equity doesn't measure up to Akre's standards. But a $42-billion cash stash in the hands of master investor Warren Buffett is a wild card that Akre thinks is worth betting on.