The Multi-Cap Value strategy is best suited for clients who: (i) seek investment performance that is not closely correlated to the major U.S. stock market indices, or (ii) look to enhance diversification in more traditional equity portfolios. The strategy aims to deliver superior returns over a full economic cycle through high participation in the upside of stock markets combined with lower downside exposure during bear markets.
- We adhere to the view that the surest way to creating long-term wealth from investments is to regularly compound capital gains, both large and small, and to avoid spending precious time – often measured in years – recouping sizable capital losses. To achieve this goal, we focus on constructing and managing an idiosyncratic portfolio of securities (the “Model Portfolio”) that seeks to outperform the major U.S. stock market indices over a full economic cycle (3 to 5 years), while assuming significantly less downside risk. We view capital preservation during down market periods as crucial to the achievement of this goal.
- In practice, this means that our Model Portfolio aims to capture most, if not all, of the market’s gains and at the same time to sidestep the worst of the market’s declines. We reject closet indexing and strongly believe that the best, and most repeatable, approach for generating superior risk-adjusted returns is to construct a value-based portfolio that differs significantly from the static, market-cap weighted construction of the major stock market averages. It follows from this that we are willing to accept periods of underperformance in the Model Portfolio versus the market averages to achieve significant long-term outperformance.
- On a broader level, we subscribe to the notion of reversion to the mean: the idea that asset prices tend to move in wide swings above and below their fair values, but eventually move back toward their historical norms. We remain conscious of the fact that financial markets move in cycles, from boom to bust and greed to fear. We believe the reversion principal is useful in identifying potential long-term investment opportunities and risks. As a result, we look to profit from (or alternatively to avoid) situations where valuations of individual securities have strayed significantly above or below their historical mean levels.
- We invest in the common stocks of companies of all sizes, mostly U.S.-based, that we believe are undervalued or have otherwise been mispriced by the market. These stocks are typically:
- out of favor in the marketplace;
- under-owned by institutional investors; and/or
- covered by few or no Wall Street analysts.
- The primary objectives of our research process are to: (i) achieve a thorough understanding of each company and the industry in which it competes, and (ii) estimate a range of fair values for the company according to a variety of profitability/operational metrics. Our focus is less on how much we might earn on an investment if our analysis proves correct and more on how much we could lose if we are wrong – which includes our judgment of the probabilities of each outcome.
- To lessen the risk of suffering a permanent capital loss, we typically seek to invest in companies that, among other things:
- sell at a significant discount to our determination of the fair value of their underlying assets;
- have historically produced high returns on shareholders’ equity and generated substantial and growing cash flows that have been profitably reinvested back into the business and/or returned to shareholders in the form of share buybacks and dividends;
- have minimal or no net debt on their balance sheet; and
- are led by a talented management team whose interests are closely aligned with the outside shareholders (e.g., maintain a substantial ownership stake in the company).
- We employ principles of behavioral finance to help: (i) identify stocks that are excessively out of favor and likely to benefit from a positive re-valuation in the future, and (ii) guard against counterproductive and destructive investment behaviors that both professional and lay investors are biologically hardwired to commit.
- We avoid investing in companies that, among other things, have historically earned less than their cost of capital (e.g., auto manufacturers, airlines), make products or rely on business models that are that at risk of technological obsolescence, or are heavily-leveraged or in financial distress. We also stay away from areas where we possess no special investment expertise or research advantage.
- While not every investment will produce a positive financial outcome, we believe (and our experience has shown) that consistent application of our value-based investment process should over time produce positive outcomes that far exceed, both in number and magnitude, the negative outcomes.
- All clients are individually invested in separately-titled accounts in the securities that comprise our Model Portfolio. We do not use pooled funds of any kind.
- The Model Portfolio typically holds on average between 20 and 35 stocks across the spectrum of market capitalization (small, mid, large, mega). The size of individual positions may range between 1.5% and 10%.
- The holdings in the Model Portfolio are diversified by, among other things: (i) market capitalization; (ii) industry group and economic sector; (iii) primary driver of expected return (e.g., upward re-valuation, sustained earnings growth, or some combination thereof); (iv) implied volatility (below-average versus above-average beta); and (v) expected holding period (e.g., long-term sustainable growth versus shorter-term restructuring).
- Not all of the economic sectors and industry groups of the S&P 500 Index are represented in the Model Portfolio, and those that are may be substantially over-weighted or under-weighted relative to that benchmark.
- Our largest exposures are in those holdings that we believe possess the most favorable profile of excess return versus below-average risk of loss; these are typically undervalued large- and mega-cap companies whose share prices should benefit from a sizable upward re-rating toward their historical mean valuations.
- Shares of small- and mid-cap companies typically comprise smaller positions; these companies are generally chosen for their sustainable long-term growth characteristics, which we believe are not adequately reflected in their valuations.
- Client portfolios typically contain a cash reserve of 5% to 15%. When attractive investment values appear, we will use the cash to purchase new stocks and/or add to existing positions. We replenish the cash reserve from the reduction and/or sale of highly-appreciated securities.
- In general, the Model Portfolio is constructed to have a relatively low correlation to the major U.S. stock market averages, so as to maximize risk-adjusted returns through superior stock selection, prudent portfolio diversification, and opportunistic use of cash.
- We will reduce or sell entirely a stock in the Model Portfolio when:
- our original basis for investment has been undermined;
- the stock is selling at an unwarranted premium to our determination of the fair value of the company’s underlying assets;
- we have lost confidence in management’s ability to run the company profitably, effect a turnaround in operations, and/or otherwise act in the best interests of outside shareholders; and/or
- a superior investment alternative becomes available.