INVESTMENT OBJECTIVE
Small Cap Growth. The small cap growth strategy seeks to outperform the Russell 2000 Growth Index by investing primarily in stocks of companies with market capitalizations generally between $100 million and $2 billion at the time of initial purchase. The small cap growth strategy closed to new investors at the end of 2006.
Small-Mid Cap Growth. The small-mid cap growth strategy seeks to outperform the Russell 2500 Growth Index by investing primarily in stocks of companies with market capitalizations generally between $500 million and $10 billion at the time of initial purchase.
INVESTMENT PHILOSOPHY
We believe that stock prices follow earnings over the long term and use fundamental research to identify companies with superior earnings growth potential and sustainable valuations. The investment process focuses on identifying stocks with a minimum of 20% revenue and earnings growth potential for at least the next two years, sustainable valuations, and a 20% upside to price target over a 12 month time horizon. Intensive bottom-up fundamental research drives stock selection, which we believe is most likely to generate excess returns. The investment process uses a team-oriented approach, where members of the team leverage the expertise of their colleagues in an environment that facilitates the exchange of ideas and insights.
There are four main steps to our investment process:
1. Idea Generation. The first step in the investment process is idea generation, and the entire team is involved in this step. Candidates are screened for specific growth characteristics regarding revenue and earnings, valuation, and expected price appreciation. Previously owned companies are a source of ideas that leverages prior experience and knowledge base. Conferences and meetings with company managements offer opportunities to monitor existing holdings and prospect for new ones. The investment team visits with company managements in our offices, at conferences, or at company locations. These visits are in addition to phone calls and conference calls with management teams. In addition, observation of trends in the environment focuses research into sectors or industries that are expected to experience superior relative growth. As a result of this process, the team identifies companies for further analysis.
2. Research and Analysis. Stock ideas undergo in-depth fundamental and valuation analysis. Seeking companies with the ability to grow revenues and earnings 20% annually, we examine growth of market, share trends, competition, and trends in margins and expenses. With a strong emphasis on the quality of earnings, we also evaluate trends in operating cash flow versus reported net income. While a company may pass our scrutiny in terms of potential earnings, it is only a candidate for our portfolio if we believe it has a sustainable valuation. To reach that determination, we review a variety of financial metrics including P/E, enterprise value/EBITDA, price to sales and cash flow return on investment. At this stage, the team develops confidence in price targets based on earnings and associated risks.
3. Portfolio Construction. With a list of high conviction names in place that the team believes offer strong risk/reward potential, the team constructs account portfolios based on client objectives and guidelines. General portfolio characteristics for our two strategies are:
Small Cap |
Small-Mid Cap |
|
| Initial position size | 0.75% - 1.5% |
1.0% - 1.75% |
| Maximum position | 4% |
4% |
| Total positions | 90 – 100 |
80 - 90 |
As a general rule, the sector weightings of a portfolio are a product of our bottom up stock selection process. Sector weights are monitored versus the appropriate benchmark (Russell 2000 Growth Index or Russell 2500 Growth Index), and are maintained within plus or minus 10 percentage points of the Index. The portfolios are fully invested and our typical cash position is between 1% and 3%, as frictional cash.
4. Risk Management. The investment team is intent on maximizing return while controlling risk. There is a daily review of the diversification and weighting limits discussed in the prior paragraph, as well as ongoing review of client guidelines and pre/post trade compliance checks. In addition, the team sells a stock when the security exceeds its price target, the original investment thesis is broken, or a better investment idea is generated. It is at this level that our sell discipline and our “non-emotional check on selling”, a proprietary 10-point quantitative system to identify problem stocks, forces a review of poor performers. See “Sell Discipline.”