How this aggressive growth fund beat the S&P 500 without Nvidia or Big Tech

Published Sun, Sep 10 20238:34 PM EDT

Many growth funds have performed on pace with the S & P 500 this year, driven by mega-cap names such as Nvidia , Alphabet and Tesla . The Needham Aggressive Growth Fund , however, has outperformed. And there's one notable difference in its holdings: it has not relied on just a few Big Tech stocks to drive its returns. According to Morningstar data, the fund is beating the Wall Street index year-to-date, up around 28% as of Aug. 29, compared to the S & P 500's 18% rise. It's also among the top 20 funds with the highest annualized five-year returns at nearly 17%, according to Morningstar. Aggressive growth funds are focused on investing in growth stocks, with high potential future to grow — but also higher risk. Longer term, the fund — helmed by portfolio manager John Barr — has managed an average annual return of 11.34% since its inception in 2001. That beats the Russell 2000 Growth index's 8.7%. Across the fund's 74 holdings, the broader technology sector accounts for 53%, while industrials comprise 16%, and health care 4.3%, as of June 30. Picking companies Portfolio manager Barr, who has managed the fund since 2010, told CNBC Pro that "there is a rich universe of investment opportunities beneath the big tech companies like Nvidia." The fund has one mega-cap tech stock in its holdings: Apple . Even then, Needham trimmed its position in the stock in the second quarter. In picking companies, Barr said he looks for three characteristics of "operational excellence": Companies with the potential to grow five to 10 times their current size, by addressing large markets and having a competitive edge. Companies investing in new products or services where the market doesn't yet recognize their potential, and also have a "cash cow" legacy unit to fund the new product. Companies with "great management," which to Barr means founders, family or long-tenured managers. "These types of managers tend to think long-term," he said. Barr also looks for the following valuation characteristic: Companies at a price with a "margin of safety," which may come from the cash flow of their legacy businesses, balance sheets, relationships with important customers, or elsewhere. "When I am right, a margin of safety purchase price may help reduce the fund's downside participation," he said. Barr started on Wall Street in 1995 at Needham Funds before leaving in 2000. He rejoined Needham in 2009. 'Hidden compounders' Barr said he would describe his style as investing in "hidden compounders," or companies with compound returns over many years. Although he begins by identifying these companies, he said the most important part of his investment process is "to hold on to these companies as they transition towards operational excellence." "[They] may exhibit revenue growth, margin expansion, and strong returns on capital. This transition may take years and some companies never make it. Over the years, most of the fund's returns have come from companies that have successfully transitioned to operational excellence," said Barr. "It is hard to hold through all of the macro noise and market turmoil that bombards us every day." The fund ultimately focuses on smaller companies "where there is less attention and a better opportunity to outperform," he said. "There are small-cap companies with rapid growth, and also with the steady growth that Needham prefers." With regards to themes, the fund has been focused on infrastructure and the reshoring of U.S. manufacturing for a number of years now, according to Barr. Within infrastructure, he likes tech, life sciences, industrials, and others. He said he prefers to invest in companies involved in the building of data centers, life sciences labs, semiconductor plants, power plants and more. "The United States has underinvested in these areas, so there could be long tailwinds," he said.

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