Our approach to value investing is based on the belief that outside investors can not consistently assess all of the material risks confronted by a publicly listed company. To mitigate these hidden risks, we combine fundamental analysis with a number of additional analytical techniques, including technical analysis & charting and statistical analysis.
Through extensive, recurrent back-testing of our methodologies and techniques, we believe that we can generate a higher Sharpe Ratio than traditional value funds by applying these additional layers of analysis.
1. Industry Focus
Our primary industry focus is driven by our career industry backgrounds, which includes:
- Energy / oil & gas
- Financial institutions
- Mining & natural resources
- Renewable energy
- Regulated utilities
While we are not limited to these industries, we often find that industry experience will alert you to market pricing inefficiencies. We will investigate opportunities beyond our core industry experience if an investment mispricing is compelling for other reasons.
2. Fundamental Valuation Analysis
Our starting point for all analysis is to determine an estimated range for an issuer's intrinsic value or, in the case of credit instruments, the realizable value of the asset backing. If we determine that a security has a material disconnect with the current market price over a wide range of inputs, then we will move onto other elements of our analysis, including timing and historical correlations.
3. technical analysis & Charting
After several years of back-testing and stress analysis, we are comfortable with using a limited amount of technical analysis & charting to lock in profits and to exit positions that have moved against us. Other sections of this website make it clear that we have a cynical perspective on many of the mainstream technical analysis & charting methods sold to the general public. More often than not, backtesting of these methods illustrates that they are doomed to fail. Having said that, there is a place for a limited amount of trading, with minimal churn, that over-rides our fundamental view and protects us from the risk that we are overlooking a material disclosure and/or recent development.
4. Statistical Analysis
We believe that there is a limited, yet important, role for statistical analysis in value investing. While there is no compelling reason why history has to repeat and it is possible that historical correlations can break down at any moment, these risks are far outweighed by the insights we can glean from multiple statistical techniques. Many of these insights simply cannot be observed from the stock price charts and/or fundamental valuation analysis.
For example, if an investor is bearish about future crude oil prices, it is not always apparent from a relative performance chart if a particular stock price moves in sync with crude oil prices. Particularly when several other factors - including the general stock market direction, interest rates, foreign exchange rates and general industry trends - can also have a material influence on the stock price. Multiple regression analysis can bring to light significant historical relationships between crude oil and stock prices that you might have otherwise missed.
Similarly, we will look at historical correlations to ensure that our fundamental analysis does not lead to a highly correlated portfolio of investments.
A large proportion of fundamental value funds & investors, believe that a highly concentrated portfolio based on high conviction ideas will lead to improved performance.
Based on our experience advising corporations over several decades, we are of the opinion that no amount of regulatory disclosures and/or analytical insights can prepare outside investors for certain business, financial, legal, operational, and regulatory risks. As a result, we continue to diversify our portfolio with a combination of inefficiently priced securities across several geographies, industry sectors and security types.
6. Insider Ownership
There is a wealth of empirical research to suggest that corporate insider activity can lead to higher risk-adjusted investment returns. While we do not dispute this, we only use insider activity in situations where there is compelling trade activity by multiple insiders. This data is always an adjunct to an existing investment thesis and we do not modify our investment conclusions based on the insider activity of a relatively small number of corporate insiders and/or a relatively small percentage (%) change in existing holdings.
7. Credit, leverage & liquidity
A great deal of our time and effort goes into studying credit agreements and bond indentures to appraise the practical reality of a listed entity's liquidity and leverage situation. Too often we find the debt summaries in the 10Ks/Qs do not convey all the information we need to reach an investment conclusion.
We also compile our own credit models to evaluate the company's credit profile based on the credit rating agency's rating criteria and guidelines.
As mentioned above, we generally use a long-term form of technical analysis & charting to determine when our investment thesis might not be going accord to plan. Similarly, as often happens with value investing, the rest of the market may take a lot longer than you would expect for a security to adjust to its intrinsic value.
Which means we may have to wait months (or even years) before we enter a position. When we finally enter a position we will often hold that investment for less than a year. We have no minimum or maximum hold period, we react to information disclosures and market developments, as well as the strength of our intrinsic value conviction about any given investment.
9. corporate governance
We are not E.S.&G. investors in the contemporary sense that these terms are used. Our investment decisions are rarely vetoed because an issuer does not meet the proxy advisor guidelines or invests in a particular sector. However, we do find that E.S.&G. structures can tell us a lot about how likely it is that management will be stockholder friendly, whether they are likely to pursue a sale of the company, and whether a hostile bidders or activist hedge fund is likely to gain any traction with their agenda.
ESG considerations yield incredibly useful insights for a value investor and we often modify our investment thesis to take account of these considerations.
10. Issuer size
We regularly screen the market for pricing inefficiencies with small and micro cap issuers. This preference for smaller issuers is simply based on the fact that, in the past, we have uncovered more patently obvious opportunities in this size universe. However, through passive networking we often encounter mid and large cap issuers with pricing inefficiencies and, while we do not go actively looking for them, we will actively engage with those opportunities when they are compelling enough for our risk/reward hurdles. In other words, we are not constrained by the size of the issuer but we spend most of our time looking for investment opportunities at the smaller end of the issuer size spectrum.