A little more than 12 months ago, I wrote an article about the Goldfarb 10, a group of 10 value funds recommended by Sequoia Fund President Bob Goldfarb. Among the stellar list of open-ended funds is a closed-ended fund that trades on the New York Stock Exchange. Part of a small but well respected group of funds managed by Los Angeles-based First Pacific Advisers, LLC, Source Capital (NYSE:SOR) is an excellent small cap for any long-term investment portfolio.

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Small Number of Stocks
It's bothersome to see mutual funds that invest in everything but the kitchen sink. Money managers do this in order to reduce company risk but all they really do is put a governor on returns. I much prefer to see a focused group of stocks that represent a manager's best ideas. Source Capital has just 41 holdings with assets totaling $594 million. The top 10 account for 46.5% of the portfolio. The higher this number is, the better. Its largest holding is automotive parts retailer O'Reilly Automotive (Nasdaq:ORLY) followed by CarMax (NYSE:KMX), Wabco Holdings (NYSE:WBC) and Signet Jewelers (NYSE:SIG).

Low Turnover
The fund's turnover is 9% annually. This means managers Eric Ende and Steven Geist trade the entire portfolio once every 11 years. Fortunately for shareholders, both have been with FPA for a long time and likely aren't headed anywhere so they'll be around in 2022 to make the necessary changes. All kidding aside, they have an incredible patience that usually pays off handsomely. Case in point is Wabco Holdings, a manufacturer of anti-lock brakes for commercial vehicles. The fund first bought shares in the company in the second quarter of 2008, picking up 60,000 at an average price of approximately $45 a share. Less than a year later, they were trading below $10. The story doesn't end there. In late January 2009, I wrote that Wabco's downside at $15 was limited and the upside tremendous. Ende and Geist must have agreed because not only did they keep the 60,000 shares, but they also bought another 400,000 in the second half of 2008 at prices between $15 and $35. Today, Wabco sits around $58. They could have sold but they hung in there and shareholders won.

Reasonable Fees
One of the fundamentals for investment success, whether using individual stocks, mutual funds or ETFs, is to reduce fees and taxes. Source Capital's annual expense ratio is 1.04%. When compared with four of the Goldfarb 10, it's more than reasonable. For instance, Bill Miller's Legg Mason Value Trust (LMVTX) has an annual expense ratio of 1.77%, despite mediocre performance in recent years. The best in terms of fees is Source's sister fund, FPA Capital (FPPTX), which has an annual expense ratio of 0.88. If you're a real stickler for low fees, you might want to check it out.

Good Performance
Just because a fund has low fees and low turnover does not guarantee good returns, but it definitely helps. Source Capital beats both the S&P 500 as well as the Russell 2500, in both 10-year and 15-year annualized returns, which is exactly what you want if you're investing for the long-term. The best part here is that we're talking about after-tax returns. Because it trades so infrequently, fees and taxes aren't a big drag on the total return of the fund. Slow and steady wins the race.

Bottom Line
If you want some small-cap exposure in your portfolio, investing in Source Capital is a good way to do so, while at the same time securing competent investment management. It's a win/win situation. (If you don't realize how "big" small-cap stocks can be, you'll miss some good investment opportunities. Check out What Is A Small Cap Stock?)

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