You don't have to be a giant company to run a mutual fund that wins multiple top awards in IBD's 2023 Best Mutual Fund Awards. In fact, you don't even need a fund that is well-diversified or has much turnover. All you need is a good pick of fundamentally sound stocks and the discipline not to sell them too soon.
Such is the case with Kinetics Small Cap Opportunities No Load (KSCOX). The $458 million fund secured the No. 1 spot in three categories this year: best U.S. diversified stock funds, best growth stock funds and best small-cap funds. In last year's ugly bear market, it gained nearly 32%.
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To win an IBD 2023 Best Mutual Funds award, a fund's performance must outpace its benchmark index in the one, three, five and 10 years ended Dec. 31, 2022. Among the few that can claim that feat, funds are ranked in each category by their 10-year average return. For stock funds, the benchmark is the S&P 500.
Kinetics Small Cap Opportunities No Load produced average annual returns of 31.96%, 26.60%, 20.93% and 18.07% in those respective periods. The S&P 500 lost 18% on a total return basis last year. And the S&P 500 only gained 7.66%, 9.42% and 12.56% annualized in the past three, five and 10 years.
It takes more than luck to achieve such impressive returns, which so few funds can match.
On top of the triple-award winning KSCOX, three other Kinetics funds were Best Mutual Fund Awards winners.
Who Are Kinetics Mutual Funds?
How did this smallish fund pull off such a huge feat? Peter Doyle and Murray Stahl co-founded Horizon Kinetics in 1994. The New York company oversees $7.5 billion in assets, including mutual funds, separate accounts and alternative investments.
Employees own Kinetics Mutual Funds. And it manages seven funds. Its investment team consists of 18 professionals with an average tenure of more than 15 years at Kinetics and close to 30 years in the industry. The managers' investment philosophy? Be the "owners of businesses."
"We own a fractional interest in real businesses," Doyle told Investor's Business Daily. "And our success or failure is going to be dictated by how those businesses grow in the future and the price that we pay today."
What Does This Best Mutual Fund Invest In?
KSCOX invests in small-cap companies. It looks for fundamentally undervalued stocks. The fund focuses on companies with small market capitalizations, such as those in the S&P SmallCap 600 index.
The fund selects names that have a solid potential to grow their valuations. The companies also showcase high barriers to entry, long product life cycles and healthy balance sheets. The managers will also consider less mature names that might have superior products or a market niche in development.
Among defining characteristics of KSCOX is that its turnover is very low. It is just 6% per year.
"When you're trying to capture the returns of the business, the only way to do that is actually to have an extended time horizon," said Doyle, who's been comanaging the fund since its inception in 2000 with co-founder Stahl.
"Once we have an investment thesis, we practice intelligent inactivity. And as long as the stock doesn't become grossly overvalued, or there isn't some competitive landscape change that's going to impair the business returns of the future, the best thing to do is leave it alone," he said.
The fund holds 51 stocks, with 51% of total assets held under one single name, Texas Pacific Land. Including TPL, top 10 holdings represent 70% of the fund.
"In my opinion, the greatest unreported investment error that people make is actually selling their best companies way too early," said Doyle. "There's this mentality on Wall Street and even among individual investors who are not professionals, that is 'the stock has gone up, let me take my original cost out,' or 'let me take some off the table,' or 'let me sell here and I'll buy back because it has run up a bit too much, and I think it's going to pull back and climb back later.' "
Top Small-Cap Stocks Held By Kinetics
Other top holdings of this Best Mutual Fund Awards winner include Civeo, CACI International, Dream Unlimited, Associated Capital Group and Icahn Enterprises.
The largest holding, Texas Pacific Land, is one of the major landowners in Texas. Its revenue consists of oil and gas royalties, land management and sales, as well as water sourcing and servicing in the Permian Basin.
"The weighting (of TPL stock) is incredibly high now, so we've been taking a little off the table," said Doyle. "But we've owned that stock professionally and personally since the mid-1980s — so we're talking a very long time. And I personally believe that the business prospects today are more or equally attractive than they were when we first (bought it)."
Doyle likes TPL because of the company's potential. Ever-improving extraction technology will find more oil. Also, he expects the price of oil to rise over time. These two factors would make the business even more attractive.
"If you were to go out and ask Goldman Sachs or Morgan Stanley to sell you a 100-year option on the price of oil, you'd pay a very high price for that and that's what Texas Pacific Land Trust has built in there," said Doyle. "So in addition to the ongoing operations, there's still a tremendous amount of oil on their property."
TPL soared 90.27% in 2022. It returned an annualized 45.64%, 40.25% and 46.46% over the past three, five and 10-year periods. The stock has increased more than 200-fold since 2003, providing investors with handsome returns. It is down 27% for 2023, as of March 21.
Another Top Small-Cap Stock Holding
Civeo is the fund's second-largest holding at 4.4% of total assets. The Houston-based firm provides hospitality services to the natural resources industry in the U.S., Canada and Australia. It offers lodging, housekeeping, maintenance, food and catering services, facility management and logistics for the personnel working in the oil, coal, liquefied natural gas and iron ore industries.
Oil States International spun off the company in 2014.
"The stock was earning $300 million-plus of cash flow," said James Davolos, vice president and portfolio manager at Horizon Kinetics. "The reason their business model was so attractive was that it was almost impossible for them to be competed with. And they had effectively no operating cost. Because these are basically just trailers that they set up in communities in the middle of nowhere."
Kinetics kept an eye on the company since 2014 and bought the stock at the end of 2020. Civeo returned 62.23% last year and was up 24% in 2021. It is down 30% so far this year through March 21.
A Look Ahead By This Best Mutual Fund
KSCOX' third-largest holding, CACI International, provides defense and security services to the U.S. government. With cybersecurity needs growing, the company stands to benefit from high demand and product backlog in the areas of surveillance, communications and other digital defense technologies.
"Because of the nature of this work, they have unique NSA security clearance, which in and of itself is a competitive moat," said Davolos. "95%-plus of their revenue is from the Department of Defense, and most of these contracts are either linked to inflation or they're at a cost-plus profit margin. So, you're almost 100% isolated from the profit-margin impact of inflation, while your customers (the U.S. government) are going to be able to pay their bills."
For this year, Doyle says there are a lot of headwinds due to prior trends such as low inflation and low interest rates recently reversing after many decades. "The typical run-of-the-mill stock, or the S&P 500 in broad terms, you're not likely to get a very satisfactory rate of return over the next five to 10 years."
Inflation will challenge markets for years to come. As a result, hard-asset investments will outperform, adds Davolos. "A lot of our funds are populated with hard asset investments. This new type of environment is going to favor those types of portfolios."
