The world's No. 1 mid-cap fund manager has a new specialty he calls 'fallen angel investing.' He explains how he's taking advantage of recent IPO failures - and shares his top 3 stock picks.

Reuters

• Equity portfolio manager Aram Green runs the top-ranked mutual fund of the past three years, and says the assorted IPO-market struggles of the past several months have created a lot of opportunities.
• While investors have grown cautious about investing in new companies that aren't profitable, he says some of those companies are inexpensive and very promising.
• It's been a rough year for a lot of unicorns that have just gone public, and Green shares the ones he thinks have the most potential.
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Looking out over the post-WeWork IPO market turns up a lot of debris, and more than a few experts are telling investors to stay away from the turmoil.

But in the stock market, one person's minefield is another person's tempting opportunity. It's gotten to the point that leading mid-cap investor Aram Green says one of his new specialties is "fallen angel investing."

Green is in charge of the ClearBridge Select fund, Kiplinger's number-one mid-cap fund of the past three years, and the third-ranked fund in that space over the past five years. He also co-manages ClearBridge's small-cap, mid-cap, and SMID-cap growth funds.

"We probably have a subset of five or six of these companies that have recently gone public. Most of them are broken IPOs and everyone's fearful of the 180-day lock up and cash needs," Green told Business Insider in an exclusive interview. "It's definitely a tidal wave of an investor angst in these companies."

While some experts think the WeWork fiasco and the disastrous market debuts of unicorns like Uber and Tradeweb show that something is wrong with the market, Green doesn't see a systemic problem. Instead, he sees an opportunity that's likely to last, as venture capital investors might be more cautious and assign these companies lower valuations for years to come.

He says traders are being overly cautious about promising businesses that are investing in future growth, and if the economics of those businesses make sense, he's comfortable betting on a company that's in the red. As he describes it, he's not taking much of a risk by buying the stocks after a shaky IPO and taking advantage of earnings pullbacks.

"We just don't see a lot of downside where these stocks are trading at now, and we have an opportunity to make 50% to 200% on our capital that we're putting to work today if we take a multi-year time horizon," Green said.

He describes online used car retailer Carvana as an earlier success story along those lines. The company made its debut a $15 a share in April 2017 and dipped under $9 a share within weeks. Green says much of the plunge stemmed from fears about the company's spending and its unfamiliar business model.

"There was a lot of skepticism over the model being profitable, whether it could actually be a sustainable business," he said. He adds that he stuck with the company and added to his position after some difficult quarters. Carvana shares are now trading at $91, a return of about 750% on Green's initial investment.

Here are three other companies that went public this year and are now part of Green's "fallen angel" portfolio, where he's hoping for similar returns.

Dynatrace

Business software maker Dynatrace popped after its IPO in August and was hit hard by the market's post-WeWork skepticism of newer companies. The stock has recovered in recent weeks but hasn't advanced much, and Green thinks it has a lot of potential.

"That's a company that's kind of been flirting around with the IPO price, but it's a company that is very profitable. It has very high cashflow margins in the business and a lot of ample runway, particularly in the upper end of the enterprise market, to do a lot of monitoring technology," he said.

SmileDirectClub

The direct-to-consumer tooth aligner company has been hit hard since its September IPO, as its shares nosedived from $23 to under $10. Green attributes much of that to the "WeWork flu."

"It's a very simple, consumer-friendly and economic offering for people to fix their teeth," he said. "We see a serial entrepreneur [CEO], they don't need access to more capital, a massive, massive market opportunity."

Still, there were some other problems, as Green says the company has struggled with regulatory difficulties and is burning cash. But he thinks SmileDirectClub has a lot of potential for expansion and is addressing those regulatory problems as well as its spending.

Lyft

Lyft stock has cratered since it went public in May, and Green acknowledges it's burning a lot of cash compared to the other "fallen angels" in his portfolio. But he's bullish on the ridesharing business in the US.

"We think that is a very developed, rational, competitive market, and it's only becoming less competitive with the market being solidified with two players that are both public, that are both driving to profitability at a faster pace," he said.

He also thinks that unlike its larger, more diversified rival Uber, Lyft could be acquired by a company that is working on autonomous driving technology. That's another source of potential upside.

"You have a lot of companies that are investing in the hard technology and the autonomous capabilities, but you still need to drive people to use some sort of fleet of vehicles, and that market is consolidated to two," he said.

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