Q: What is the history and objective of the fund?
A : TAMRO Capital Partners is a majority employee-owned investment adviser specializing in U.S. equities. The firm founded in June 2000 is located in Alexandria, Virginia and manages assets of $1.2 billion.
The Aston/TAMRO Diversified Equity Fund was launched in January 2003. The objective of the fund is to provide long-term capital appreciation and outperform the market over a full investment cycle.
Q: Why do you follow the “core” style of investment?
A : We don't consider ourselves value or growth investors. History shows growth and value investment styles and industries rotate in and out of favor. But style and industry cycles can persist for years. We're more opportunistic and our core approach enables participation in all market environments. We’re stock pickers and looking for the best, relative opportunity to invest and our diversified portfolio is created with the goal of generating risk-adjusted returns with a focus on stock selection.
Q: What is your investment philosophy?
A : Our belief is that companies with a sustainable competitive advantage generate both premium returns and command premium multiples. However, company miscues or industry headwinds can cause these companies to sell at a discount as investors focus on near-term difficulties and overlook longer-term potential. We capitalize on the investment opportunity created by this mis-pricing.
We seek to invest in companies that have a sustainable competitive advantage where the potential upside at the point of purchase is at least three times as great as the potential downside.
Q: Would you explain your investment strategy?
A : The investment seeks long-term capital appreciation. The fund invests at least 80% of assets in equity securities. The investment process focuses on bottom-up stock selection and our investments can range from REITs, foreign securities, convertible bonds and, to a limited extent options.
Q: What is your research process?
A : The Aston/TAMRO Diversified Equity Fund employs a bottom-up stock selection with the goal of identifying companies that possess a sustainable competitive advantage combined with an attractive valuation. We focus on companies with a management team that has a proven track record of success and leading market share in their core products or service offering.
Using a combination of quantitative tools and qualitative assessment, we identify undervalued companies with a competitive advantage. We attempt to mitigate our investment risk by purchasing stocks where, by our calculation, the potential gain is at least three times the potential loss (a reward-to-risk ratio of 3:1 or greater).
We have a five-step investment process. The first step begins with a scoring system and is the idea generator. Most investment ideas are generated through an internally-developed quantitative model that identifies companies with attractive valuations and improving earnings expectations. Valuation metrics used are tailored to the industry in which the company resides and the highest scoring stocks are candidates for qualitative analysis.
The second step is industry research. Our investments fall into three different categories - Leaders, Laggards and Innovators - all share the key characteristics of a sustainable competitive advantage of a differentiated product or service offering, capable and motivated leadership, and financial stability.
Using a 13-factor industry matrix, we seek to identify a company’s investment category. Leaders have historically produced outsized returns, but are experiencing short-term difficulties; Laggards have failed to generate value over time as evidenced by poor historical performance and depressed margins and Innovators support product and service introduction through a significant commitment to research and development.
The third step is the company analysis wherein we determine whether a company possesses a strong core business that can provide a competitive advantage over the long term, while understanding the company’s near term business risk and the stock’s valuation risk.
Our fundamental analysis encompasses a rigorous review of corporate financials and filings, interviews with management and a study of key competitors. We focus intently on the quality of the company’s product or service offering, leadership and balance sheet and determine whether operating performance and profitability are likely to improve or weaken.
Valuation analysis is a key component of our process and we will invest only in companies that offer a reward-to-risk ratio of greater than 3:1. Using the most relevant financial metric, and considering a company’s business and profit cycle, we arrive at a reward-to-risk ratio for each potential investment.
The fourth step of our investment process is portfolio construction. Our bottom-up research effort results in portfolios of 50 to 70 of our best investment ideas. To ensure diversification, we have set parameters for how much we can over or underweight sectors versus the product’s benchmark and a typical position size is 1.5% to 2%. How we are positioned at the sector and investment category level is a result of where we see opportunity at the stock level.
The fifth step is portfolio monitoring. We monitor our stocks closely to ensure that company and industry performance is consistent with our investment thesis. We will part company with a stock due to stretched valuation (we update each company’s reward-to-risk ratio weekly), loss of confidence in management or to fund more attractive relative opportunities.
Q: How would you describe your sell discipline?
A : We sell stocks for three reasons. First, if the upside/downside ratio of 3:1 of a stock reaches its target price, we tend to take profits and look to redeploy the proceeds by selling the stock. Second, a management's inability to execute to whatever plan they have articulated or we don't think they can and the stock reflects that, we look for other attractive opportunities. Third, we sell stocks to take advantage of the volatility to the downside.
Q: What are some examples that best illustrate your research process? *
A : For instance, we held the stock of Starbucks Corporation which is an international coffee and coffeehouse chain. The stock of the company which was $40 gradually sold off into the high single digits at one point. But when Starbucks started to score well we decided to look closely at its fundamentals and valuations.
But we thought despite having done so well for so long before 2007and 2008, it turned into a laggard especially with the departure of the founder and CEO Howard Schultz. The returns, share price and profitability of the company were depressed.
Though Starbucks had a great core business they had expanded at a rapid pace. The store location quality had slipped and they weren’t roasting the beans in as many as stores as they used to. But Schultz returned as the CEO again and significantly brought back some of the people that had helped him build the company and laid out a restructuring.
There was a significant slowdown in new store openings to the point where the last couple of years it ran almost flat to negative because they were closing more stores than they were opening.
They had the characteristics of sustainable competitive advantage and the financials were strong. They brought in the guy who built the business. He laid out a very clear plan to improve operations and profitability and then it was a question of what's the stock worth because this was a company that historically had traded on a revenue's basis at 2.5 to 4.5 times.
We didn't expect Starbucks to be the growth stock that it was in the past but we expected profitability to improve dramatically. What's interesting is even though the stock used to trade at more than four times sales when it was a 50% gross margin enterprise, it traded down to under one-time sales and gross margin had fallen into the 40s. Moreover, on an operating basis, valuation was down to under one-time revenues and looked cheap to us.
That's kind of a classic laggard where the 3:1 ratio was easily cleared and they still had a sustainable competitive advantage but were mismanaged for a few years and we understood the restructuring plan that was put in place.
Another example would be Joy Global Inc., the worldwide leader in high-productivity mining solutions. When the global economy slowed, this stock went from $90 to $20 but what caught our attention was the company reported better than expected results.
It started scoring well on our screens and matrix. This was a clear leader. It was a strong company with a strong culture, historically had done very well in the heavy equipment space, and the best in class enterprise when we looked at how it had performed relative to its peers.
The stock was trading at one-time sales and revenue was depressed because demand had fallen off and the profitability was actually holding up reasonably well because they were cutting cost so much. They were a clear leader within the industry and management was doing what they could to manage through a very difficult environment. In the longer term the company’s prospect looked good to us as the demand for material handling equipment is expected to be robust as global demand for coal, iron ore and other metals will be supported by a rapid urbanization in China and India.
Also, Joy Global is a leader in its industry that historically hadn’t traded down to where it did in 2008 and 2009 and we had a chance to finally get into a best in class mining equipment company at a very attractive price. That's a case of a leader whereas Starbucks, which is no longer in the portfolio would be more of a laggard.
Q: How do you execute your portfolio construction?
A : We build the portfolio bottom-up with one stock at a time and that's where we tend to add value in terms of attribution at the stock selection level. We do set parameters around how much we will overweight or underweight major/minor sectors in the benchmark so we end up with a broadly diversified portfolio.
Generally, the portfolio consists of between 50 and 70 names and currently it holds approximately 58 positions. Typical position size will vary between 1.75% and 2% of the portfolio and we won't let any one position become more than 5% of the portfolio and so how we ultimately position at the sector level outside of the parameters is a result of where we see opportunity at the stock level.
The annualized three-year turnover is 77% which is elevated due to the volatile market conditions of the past two years. The referenced benchmark for our fund is the Russell 1000 Index.
Q: What do you consider as sources of risk and how do you manage them?
A : We work very hard to manage risk at the company level and that gets back to understanding the fundamental characteristics and then buying the underlying common at the right price when we have that upside/downside ratio of 3:1 at a minimum.
Our belief is that by working hard to manage risk at a stock level over time, we'll manage risk across the portfolio. We do again have parameters in place in terms of sector exposure and that is also diversification and risk management but for us, it really gets back to managing risk at the stock level very well and hopefully over time that will translate into attractive risk-adjusted returns across the portfolio.
{{*The examples described above are being used to illustrate the details of TAMRO’s investment process and may not be representative of current or future investments. It should not be assumed that these holdings were or will be profitable. The information provided in these examples should not be considered a recommendation to purchase or sell or sell any particular security. To request a complete list of all recommendations made within the strategy during the past year, contact HYPERLINK "mailto:tamro@tamrocapital.com" o "blocked::mailto:tamro@tamrocapital.com" tamro@tamrocapital.com.
The various metrics used above were approximate values as of 12/31/09 and are subject to change.}}
