Q: What is the history of the fund?

EntrepreneurShares started in 2005 when I was a Professor at Babson College and had recently published a book, “Getting Bigger by Growing Smaller”. I was also selling, The Shulman Review—a CFA test prep company that trained over 12,000 investment professionals in 110 countries around the world. Hedge funds were very hot at the time and a few of my students (from both Babson and CFA Program) suggested launching a long-short equity hedge fund. I was able to procure $5M in seed capital and launch the fund in 2005 with a new proprietary strategy (long entrepreneurial public companies and short bureaucratic companies).  Five years later, in 2010, we launched our first mutual fund, utilizing the same strategy with a Global long-only strategy. 

Since its start, EntrepreneurShares has experienced some growth.  We currently offer several mutual funds: the Entrepreneur U.S. Small Cap Mutual Fund (IMPAX), the Entrepreneur U.S. Large Cap Mutual Fund (IMPLX), and the Entrepreneur Global Mutual Fund (ENTIX).  

In the near future we will launch the Entrepreneur 30, a rules-based index fund that will be an exchange-traded fund. We are also working on some other SMAs (and recently received two commitments for a Non US Small Cap separately managed account).

The total assets under management for all of EntrepreneurShares are just about $400 million.

Q: What are your benchmarks?

We have a growth tilt, so two-thirds of our stocks tend to be growth-oriented. The benchmark for the EntrepreneurShares U.S. Small Cap Fund is the Russell 2000 Growth Index, for the EntrepreneurShares U.S. Large Cap Fund it is the Russell 1000 Growth Index, and for the EntrepreneurShares Global Fund it is the MSCI World Index.

And we use the Vanguard FTSE All-World Ex-U.S. Small Cap Index Fund for our non-U.S. Small Cap Fund.

Q: What defines “entrepreneurial” for you?

Our global entrepreneurs need to meet the standards of our proprietary 15-Factor Entrepreneur Model. This model determines whether or not a company classifies as an “entrepreneur.” It’s based on a number of factors that examine, people, leadership, growth and other management characteristics. 

We like to see low turnover among managers, executives who aren’t selling their stakes after a few years, a company that grows organically, has low SG&A (selling, general and administrative expenses), high R&D investment, and a number of other key factors such as revenue and profit considerations. 

The new rules-based ETF we’re rolling out in November has a similar approach. We’ve closely monitored our performance over the past eight-nine years using a factor analysis and know that we are more than just a growth or momentum shop. In the past eight to nine years since the 2008 recession, our ER 30 Index has generated a return of 485%, with more than 230% above the S&P 500 Growth Index. 

Bloomberg’s Factor Analysis shows that the sum of all the style and sector factors such as momentum, earnings, growth, leverage, etc accounts for approximately 26% of the 230% excess returns. It shows how more than 200% of the 230% excess return can be attributed to our selection factor which stems from our entrepreneurial model.

Essentially, what we are discovering is that strong leadership helps generate long-term investment performance. Our Entrepreneurial Factor refers to solid management characteristics. 

Q: Would you say you focus on lagging indicators rather than leading indicators?

It’s a little of both. Companies in our investment portfolio tend to exceed investor expectations.  They may accomplish this by either squeezing more benefits through SG&A reductions, expanding gross margin or EBIT/EBITDA over time, or widening the trading multiple. 

Our thesis, in a nutshell, is to look for entrepreneurial companies that are strong in ESG (environmental, social and governance) and Impact. Our portfolio companies have strong governance traits that create jobs, yield strong performance to shareholders, and are led by people who are visionaries/stewards of their companies. Company leaders have a long-term orientation and are not simply in it for profits or quarterly returns. 

If we discover that corporate leaders have changed their orientation and are no longer interested in growing organically, (for example, they are only interested in acquisitions that may not accrete shareholder value), then we will likely eliminate that investment. 

We believe we are the only firm that invests with an Entrepreneurial model. Moreover, we manage our funds through an advisor named Capital Impact Advisors. We invest in companies that provide impact to their communities. Our investors generate nice returns while also investing in companies that create social benefits.

We know at the end of the day our funds deliver consistent performance. Long-term organic growth among our portfolio companies is a primary factor. It is likely some combination of high growth, better gross margins, and SG&A reductions over time that enables our portfolio companies to outperform their peers.

Q: What is your investment process?

It’s primarily quantitative with a few qualitative issues needing to be categorized. We use multiple databases to source our data, which we run through a series of fifteen proprietary filters. 

We then weight our securities based on active share relative to our benchmark. 

Q: How would you describe your research process?

The research process is all bottom-up. We start with 55,000 global companies and immediately eliminate a number of equities based on the liquidity and appropriateness of the market. We won’t invest directly in some emerging markets such as India or China, though we will certainly participate through ADRs (American depositary receipts). 

In order for us to embrace limited exposure in the BRICS countries (Brazil, Russia, India, China) we require sufficient liquidity for us to get in and out.

Our model works best in an environment where there is good rule of law. In each of the BRICS, we look to ensure reputable auditors are there to avoid incidents of fraud. 

We also look at sector weights relative to our benchmarks. In developed markets, for example, we may be overweight IT, healthcare, consumer discretionary financials. We are typically heavily underweight industrials and utility companies. 

The Global Fund ranges between 60% to 40% weight between U.S. and non-U.S. companies, respectively. We also offer pure-play strategies outside the US.  For example, our Small Cap non-U.S. fund is currently our best performing fund. YTD through mid-September, it has appreciated more than 43%. 

Q: How do you rebalance the portfolio?

At minimum, we rebalance our portfolios each quarter. We examine the financial statements and check for changes to growth, level of acquisitions, R&D investments, changes in compensation, ownership, and management departures. We also monitor for changes in market cap—if they’ve become too large or small for our category. 

The Global Fund tends to be a little bit more difficult to rebalance due to tracking error. We want to be comfortable with tracking error relative to our benchmark.  We first assess which of our entrepreneurial companies are in the benchmark and then gauge whether other names meet the broad characteristics. If they’re not in our benchmark, we have to determine whether it is something we want to embrace and add tracking error. 

Another reason to rebalance may occur when we remove a tech or healthcare company because it slows down its investment in R&D. We also may remove a company that completes a monster acquisition without creating SG&A savings or margin enhancements. 

For example, when Black & Decker Corporation and Stanley Works merged to become Stanley Black & Decker, the CEOs fired 5,000 people and SG&A didn’t go down—it actually went up. What we don’t like to see are people at the top who think that because they are now at a bigger company, they are worth more, and award themselves a bonus simply because they did an acquisition. Worse is when they fire lots of people and enrich themselves. At Stanley Black & Decker, employees really resented the synergistic bonuses executives got after firing employees. It invites criticism and makes staff less motivated to work hard for them.

That said, we are not against acquisitions. There are plenty of entrepreneurial companies that do acquisitions and do good things with them. We just want to ensure the companies doing them tend to accrete savings. 

In many cases, entrepreneurial companies have a long-term vision, and a typical CEO might be there 15 years or more and retire at 70 or 75 instead of electing to get out at 62 or 63 with $20 million in his/her pocket. If, suddenly, three or four of the top directors leave at age 55 or younger, then we start to become very concerned.

We look at the way a company grows, whether it’s by acquisition or organic, and we look at the R&D and the incentive systems at the company. If all of a sudden executives start compensating themselves more without corresponding performance, we may get very concerned. We also monitor executive buys and sells. 

Q: Generally, how many new names are added or eliminated during the rebalancing?

We review many names, but generally remove fewer than five or six names per quarter. 
In general, it tends to be 10% to 15% per year.

Q: How is the research team organized?

Because I am a professor at Babson College, I have research fellows at Babson to help me, along with a fairly unlimited supply of Babson students who want to work here. 

Between our interns, and employees, it’s a solid team. While it’s not exclusively a Babson shop, it’s largely Babson driven. This is a young, high-energy group with a median age of probably 25. We all work well together.

Q: How do you define and manage risk?

Our biggest risk is variance from our benchmark. We focus on tracking error, deviation and the variance relative to our benchmark. And because we tend to be concentrated in three different sectors – healthcare, IT and consumer discretionary—our portfolios work best in growth environments and poorly in value environments. 

Before investing, investors need to know which environments favor the strategy underlying the investments they choose. A strategy is not going to work all the time, regardless of environment, so they should know when a strategy works best and when it doesn’t. We always want our investors well prepared. Our investors know we thrive in growth-oriented markets and do not perform well in value-based markets.