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Hennessy Steps Up To the Plate

Here's a strange tendency that I've noticed: a surprising number of money management companies' stocks have exceeded the returns of their managed funds.

Let's take the hypothetical case of two individuals investing in Eaton Vance (NYSE: EV  ) in December of 1979 and selling in December 2004. One invests in the company's flagship fund, Eaton Vance Tax-Managed Growth, and the other in the company's stock. Assuming that both individuals reinvested all their respective dividends and distributions, today both investors would find themselves pleased with their foresight -- but one would be significantly happier than the other.

The investor who put his or her money in Eaton's fund would be looking at 20.9 times the return on investment, which is very respectable. But the investor who put his money in Eaton's stock would have received 1,060 times the amount invested.

Surprised? Wait, there's more. Not only did Eaton's returns on its stock price obliterate the returns of its top fund, but it also ranked as the No. 1 publicly traded U.S. stock over the past 25 years, with a 32% annualized return.

I'm not cherry-picking Eaton Vance to make a point, either: Legg Mason (NYSE: LM  ) , Affiliated Managers Group (NYSE: AMG  ) , Franklin Resources (NYSE: BEN  ) , and T. Rowe Price (Nasdaq: TROW  ) shares have well outperformed market averages over the long term, and their shares tend to outperform their funds.

There's a structural reason for this: As a rule of thumb, investment management firms are valued at about 1% to 2% of assets under management. This comes from two sources: new dollars invested, plus investment gains. Fund clients' only gains come from return on investment.

Assuming that you accept my train of thought, your next question should be, "Where do I find a fund management company that has the majority of its growth still in front of it?" In April, Bill Mann suggested that Motley Fool Hidden Gems subscribers look at a tiny fund management company named Hennessy Advisors (OTC BB: HNNA).

Already a publicly traded company, Hennessy recently filed a registration statement today with the SEC for a secondary public offering. The offering is structured to raise up to $48 million as the company moves from the over-the-counter exchange to the Nasdaq.

Hennessy's fund management strategy is entirely mechanical, which means that the biggest costs for most funds -- paying the managers -- doesn't apply. The software running the formulas that determine the components of Hennessy's funds doesn't whine for salary increases.

In addition to maintaining steady fund growth since it was first established in 1996, Hennessy Advisors had a 17.95% return on assets, a 30% return on equity, and a 29.77% profitability margin for the last fiscal year. With a nine-year track record, low management costs, and the emerging pattern, Hennessy Advisors' move to the Nasdaq is primed to give early investors a good chance at significant returns in the future.

Hennessy Advisors was a Tiny Gems selection for theMotley Fool's Hidden Gemsnewsletter. Each month, Tom Gardner and Bill Mann select micro-cap stocks that interest them. A 30-dayfree trial, as the word "free" suggests, costs nothing.

Foolish internAndrew Pattersondoes not own any company mentioned in this article.

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