Why This Top Mid-Cap Manager Still Likes Tech Stocks

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Mid-cap companies are usually defined as having a market capitalization of $2 billion to $10 billion, but Amy Zhang prefers to measure by revenue instead.

As the portfolio manager of the $475 million

Alger Mid Cap Focus
fund (ticker: AFOZX), Zhang looks for smaller mid-cap companies—those with revenue of $500 million to $1 billion—that generate strong free cash flow and operate in a field large enough to allow them to take market share. That enables shareholders to benefit from compounding as the company grows. “To use a baseball analogy, these companies are in the third or fourth inning,” she says.

A no-load fund, Mid Cap Focus’ three-year annualized return of 14.9% puts it in the top 10% of its peers, handily beating the mid-cap growth category and the Russell Midcap Growth index, net of the 0.68% annual fee. It is sold largely through financial advisors and has an investment minimum of $500,000. Mid Cap Focus A shares (ALOAX), which are the same investment, are now available for a $1,000 minimum and a 0.96% fee at brokerages such as Charles Schwab and Fidelity. There is a 5.25% initial fee.

The fund has lagged behind the index in the past year, as value stocks have held up better in a down market than growth stocks. But Zhang is sticking to her guns, buying beaten-up tech stocks that she regards as bargains.

Her differentiated investing approach comes from 20 years of managing both small- and mid-cap growth strategies, including 13 years co-managing the Morningstar gold-medalist

Brown Capital Management Small Company
fund (BCSIX). She joined Alger in 2015 to launch

Alger Small Cap Focus
(AGOZX), and in 2019 launched the four-star, Morningstar silver-medalist Mid Cap Focus fund.

Zhang seeks firms with business models that produce durable revenue growth with earnings visibility, such as subscription models or companies that supply critical components. She wants firms that can grab share and maintain an advantage with time-saving or problem-solving products.

“These firms are valuable and differentiated; they can have pricing power, which is very fitting in this market,” she says.

Alger Mid Cap Focus	YTD	1-Yr	3-Yr
AFOZX	-27.6%	-16.6%	14.9%
Mid-Cap Growth Category	-20.9	-21.3	9.5
Top 10 Holdings
Company / Ticker		Weighting
Natera / NTRA		4.2%
Constellation Energy / CEG		3.9
Insulet / PODD		3.4
Avantor / AVTR		3.2
Everbridge / EVBG		3.1
Palo Alto Networks / PANW		2.8
Bentley Systems / BSY		2.8
Diamondback Energy / FANG		2.8
KLA / KLAC		2.8
Alteryx / AYX		2.7
Total:		31.7%

Note: Holdings as of August 31. Returns through September 12; three-year returns are annualized.

Sources: Morningstar; Alger

Strong managers are key, and Zhang looks for a “sort of yin and yang,” meaning firms that have a visionary CEO and a chief financial officer focused on profitability, to balance growth and profitability. She shies away from companies that aren’t focused or don’t have an efficient sales strategy.

Mid Cap Focus is a high-concentration portfolio of about 50 names, and Zhang prefers to hold companies for three to five years, using intrinsic value as one reason to buy or sell. The three years since she launched Mid-Cap Focus have been volatile, leading to significantly more turnover than she’d like—as much as 250% last year.

After Mid Cap Focus returned nearly 85% in 2020, she sold several highflying names, including user-authentication company

Okta

(OKTA) and videoconferencing firm

Zoom Video Communications

(ZM), noting that “they really overshot their valuations.” Mounting inflation and the Federal Reserve’s interest-rate-raising campaign prompted other sales.

The current market cycle favoring value is hitting Mid Cap Focus’ year-to-date and one-year returns, down 28% and 33%, respectively. The fund is in the bottom 10% versus peers and is lagging behind the index.

Another reason for the fund’s weak performance is a slight overweight in technology versus peers and the index this year. Zhang describes it as an opportunistic move as she looks to “find the gems in the rubble” of this year’s tech selloff. She says several tech firms remain high-quality companies as their multiples contracted.

One of the companies Zhang bought during the tech rout earlier this year was

CrowdStrike Holdings

(CRWD), re-establishing a position in the cybersecurity firm after taking profits in late 2021. The first-quarter tech selloff made the firm attractive again from a long-term perspective, she says.

She considers CrowdStrike an emerging leader in the enterprise endpoint security market, an end-user device security system. CrowdStrike is taking market share from companies such as

Qualcomm

(QCOM) and McAfee, she says. The cloud-based system is different than competitors’ offerings, since once customers buy the system they often add additional services, creating durable revenue streams. “It’s both a high-unit-growth and expansion-of-wallet share,” she says.

Another recent tech addition is payroll-service provider

Paylocity Holding

(PCTY). It competes against the likes of

Automatic Data Processing

(ADP) and

Paychex

(PAYX) and currently has about 33,000 customers—compared with one million combined for ADP and Paychex, she notes. It is also expanding into human-capital management. Zhang hopes that Paylocity can be a long-term compounder, noting that it increased business during the pandemic.

A number of the companies that Mid Cap Focus owns have pricing power, which should mitigate inflation pressure. One example is

Heico

(HEI), a company with two business units: a replacement-parts supplier for aircraft, and one for electronics for niche applications in aerospace and defense. As a Federal Aviation Administration–approved third-party parts supplier, Heico makes parts 20% to 40% cheaper than original-equipment manufacturers and is the largest in its category. FAA-approved aftermarket-parts suppliers represent only 3% to 4% of the commercial aerospace aftermarket, providing a long runway for growth, she says.

After the volatility of recent years, Zhang feels the portfolio is set up well. The companies she owns have strong balance sheets and little need to tap capital markets for funding, shielding them from higher rates.

“I feel very good about the next one to three-plus years. I think most of the bad news regarding rates are priced in,” she says. “Even smaller companies can grow in a rising-rate environment, when you have the strong balance sheets where you can be self-funded and you have some truly idiosyncratic drivers.”

Email: [email protected]