Though he doesn't have the name recognition of a Warren Buffett or a David Einhorn, Seth Klarman can easily be classified as a mega-investor. Klarman's fund, Baupost Group, is the world's 11th largest hedge fund, and it manages a sizable equity portfolio.
Though it's tempting to assume that retail investors should pay attention to Klarman's large-cap holdings, our research actually shows that hedge funds' top small-cap picks generate significant alpha.
With this in mind, let's take a look at Klarman and Baupost Group's top five small-cap picks; each had a market capitalization between $1 billion and $5 billion at the end of the third quarter. This is the same criterion used in our research that's mentioned above.
ViaSat (VSAT) is Klarman's favorite small-cap stock, sitting at the No. 3 spot in his 13F portfolio. Shares of the high-speed broadband provider have had an uneventful 2013, losing a little more than 1%, and the company has reported a loss in three straight quarters. ViaSat's launch of its own communications satellite in 2011 has many long-term investors sold on the idea that satellite-supported broadband can eventually be on equal ground against its more traditional competitors.
ViaSat isn't valued particularly well at the moment, but the sell-side expects a massive leap in earnings growth over the next half-decade. Early estimates predict annual EPS expansion of 19% to 20% a year; ViaSat's bottom line shrank by nearly 30% a year over the preceding five-year time frame. In addition to Klarman, hedge fund managers Murray Stahl and Israel Englander are both key names invested in this stock.
Theravance (THRX) meanwhile, is the hedge fund manager's second favorite small-cap stock. Theravance is up a little more than 18% in the past 12 months, and investors are optimistic on the biopharmaceutical company's partnership with GlaxoSmithKline (GSK). Last month, the two announced they're seeking approval of Anoro, a drug for chronic obstructive pulmonary disease. Generally speaking, respiratory treatments represent the best growth potential for Theravance, but shares don't look particularly attractive at 16x sales and 12x book. Ardent investors may be best served by waiting for a more attractive entry point into this stock.
Next up we have Allied Nevada Gold (ANV). As its name suggests, Allied Nevada has the majority of its operations focused in Nevada. Allied's Hycroft property represents the biggest growth driver for the gold miner, but full capacity isn't expected to be reached until 2015. The sell-side does expect EPS growth in excess of 150% next year -- they're predicting flat growth this year -- and investors aren't paying an arm and a leg for the stock at the moment.
ANV currently trades at a mere 15.8x forward earnings, and while there's nothing here for income-seekers, seven of the 11 Wall Street analysts that cover this stock hold buy ratings. As a whole, the group's average price target on Allied Nevada represents an upside in excess of 80%. It's easy to see why Klarman is invested in this stock.
NovaGold Resources (NG) is Klarman's fourth largest small-cap holding, and unlike Allied Nevada, shares aren't particularly cheap at the moment. Bullish investors expect NovaGold to sell at least half of its Galore Creek stake this year, though nothing has been confirmed as of this writing. Wall Street expects earnings growth in excess of 100% this year, and analysts' average price target forecasts that shares will double to a price north of $9.50.
Genworth Financial (GNW) rounds out Klarman and Baupost's top five. The diversified insurer, which also offers wealth management services, has seen its stock price pop by more than 22% year-to-date. Much of this appreciation has been on the back of reports that it will splinter off its mortgage insurance operations into a separate business. In addition to this bullish move, shares of Genworth trade at generally depressed forward earnings (7.3x), book (0.3x) and cash flow (1.2x) multiples. With Q4 earnings on deck next week, a solid quarter will likely pull more value-seeking investors into this stock moving forward.
-- Written by Jake Mann