We focus on the upper end of the small cap and the lower portion of mid cap companies. Currently we view the group as being between $750 million and $15 billion in market cap.
Within this universe, we look to identify companies that offer strong business models, attractive margins and superior management teams. The research process is extensive as we drill down on many of those ideas that we believe may be potential investments. We are bottom-up, fundamental research-focused investors. The macroeconomic environment will be considered in the context of the investment, but a stock must have strong attributes on its own to be purchased.
A distinguishing characteristic of our approach is that we invest in three different types of growth in the portfolio, which we identify as:
Mispriced Growth are companies in which some sustainable change is occurring that we think will lead to a higher level of earnings, revenues, cash flows or margins over the ensuing two to three years. Further, we believe that the market has not fully recognized the potential impact of this change in the stock price. Mispriced growth stocks are normally 50-to-70% of the portfolio, and normally our best returns have been earned in this group. These stocks tend to do best in rising markets, however, this group has not been as resilient in negative market environments as steady eddies.
Steady Eddies comprise 20-to-50% of the portfolio and can be characterized as being stable growth companies. While their growth rates typically are not as high as the mispriced growth stocks, they have tended to have a more consistent quality to them. This can be due to a high level of recurring revenues. These stocks typically have held up well in declining markets, for the obvious reason that in that environment the market tends to be looking for companies with some predictability or stability to their earnings. We believe these stocks provide a defensive ballast to the Fund and have been a significant contributor to our strong downside capture ratio and lower overall standard deviation.
Turnarounds, which can be anywhere from 0-to-10% of the Fund are companies in which something has occurred to take the company from its growth path. In order to consider a stock a 'turnaround', we must see a catalyst in place that we believe will fix the problem and some evidence that organic growth is beginning to return to the company. The performance of these stocks is less predictable (relative to overall market conditions) than the other two categories. However, historically when these stocks work they have added a nice performance boost to the portfolio.
The combination of these three distinct and complementary types of companies help to reduce volatility and tend to offer a level of protection in down equity markets.
