The three-year mark is a critical milestone for any new mutual fund, and a manager’s performance over those critical early years can define a fund’s success. With the financial crisis serving as its proving ground, this offering has weathered the worst of times.

The conventional logic would argue against opening a mutual fund amid the worst financial crisis in a generation. Walthausen Small Cap Value (WSCVX) launched in February 2008, one month before investment banking giant Bear Stearns collapsed under the gathering weight of the mortgage crisis.

For some, crisis equals opportunity. As portfolio manager John Walhausen stated in the fund’s first semi-annual report, “One aspect to the art of investing is to see what value is created as other investors sell positions and move to the sidelines during such a period of volatility and uncertainy.”

In the first six months of the fund’s life, Walthausen Small Cap Value gained 3.3 percent, compared to a 1.2 percent loss for its benchmark, the Russell 2000 Value index. Although, the fund went on to finish that fiscal year with a 29.5 percent loss, this still outpaced the 36.5 percent decline recorded by the benchmark. But 2009 was the breakout year for Walthausen Small Cap Value, when bets on industrials, consumer discretionary names and energy stocks fueled a 59.9 percent gain in the fiscal year ended Jan. 31, 2010, handily outpacing the index’s 36.5 percent return.

The latest fiscal year saw the fund return 43.7 percent, trouncing the Russell 2000 Value index by 15.3 percentage points, on the back of a portfolio overweight in consumer discretionary, industrials and materials stocks. You can hardly argue with the results. This short, but impressive, track record has vaulted the fund to the top 1 percent of Morningstar’s Small Cap Value category over the trailing three years.

The secret is a bottom-up evaluation of names that other sin the market may have written off.

“As investors we’re mostly looking for fairly instant gratification,” John Walthausen told Louis Rukeyser’s Mutual funds. “Investors tend to be dismissive of companies that have been dull for quite a while or have had some trouble. Investors are often enamored with companies that have done extraordinarily well over a long period of time.”

The Pep Boys—Manny, Moe & Jack (NYSE: PBY), an auto repair chain founded when the Model-T was state of the art, is a classic example of Walthausen’s approach to selecting undervalued stocks. The company enjoyed decades of strong performance and went on to become fodder for growth funds in the 1970s and 80s and much of the 90s. But the company stumbled in the new century and the stock eventually sold down to close to book value.

Walthausen’s proprietary screening methodology turned up Pep Boys and management was intrigued by the firm’s management changes, improving same store sales growth and operating margins. Pep Boys has focused on providing more auto services rather than just parts for the DIY-crew and has steadily acquired repair shops that play to this vision for the company. These improvements indicated to Walthausen that the firm was executing better on the minor details that are critical to success for retailers.

Walthausen added the stock to the portfolio half a year ago and is opportunistically building upon the position. Although Pep Boys failed to wow the Street with its latest quarterly results, the company will benefit from an inexorable trend—consumers can’t put off car repairs indefinitely.

This focus on execution also underpins Walthausen’s investment in subprime mortgage servicer Ocwen Financial Corp (NYSE: OCN). The fund established a position in the financial firm almost two years ago when the word “subprime” was a four-letter word. But Ocwen was able to keep delinquency rates at manageable levels, due in large part to the power of the firm’s proprietary software. Although Walthausen says that the firm hasn’t been a “stellar performer,” Ocwen’s stock hit a 52-week high in mid-June.

Small-cap stocks have gone on a run over the past years—the Russell 2000 index returned 26.3 percent in in the trailing 12 months alone. This outperformance has led many to question whether small caps are in for a painful correction. Although the market’s whims are impossible to predict, Walthausen said the wisdom of the crowd is often a poor guide.

“I’ve heard and awful lot of people say that small caps have had their day,” Walthausen said. “They may be right. But the consensus has an enormous history of being wrong.”