Q: What is the history of the fund?
A : The Robeco Boston Partners Mid Cap Value Fund was launched in June 1997 and is managed by Robeco Boston Partners, a division of Robeco Investment Management, Inc. Currently, it has $140 million under management.
The primary investors in the fund has been on pension funds and other retirement plans, endowments and foundations and larger institutional clients.
We invest in mid-caps because we believe these companies are small enough to continue to grow yet large enough to have financial strength. They occupy what I call the sweet spot: they are less widely known than large caps and they have greater liquidity than small caps.
Q: What core beliefs or principles drive your investment philosophy?
A : First and foremost, we are value investors. We select stocks of companies that trade for less than their intrinsic value. We believe the market overreacts to good and bad news, resulting in stock price movements that do not correspond with the company's long-term fundamentals. The result is an opportunity for value investors to buy when the price is deflated.
We focus on what beats the market averages over reasonably long-time periods, namely value and momentum. Fundamental analysis works well when it is firmly grounded in these two principles.
Second, we look for strong business fundamentals. We look for high-quality companies because they tend to outperform over the long term. Companies with a high return on capital are more likely to create shareholder value whereas those with lower returns tend to destroy value over time.
Finally, we focus on business momentum or a catalyst for change such as restructuring, change in management, or new products. These are all reasons why we believe the stock price may move towards our target over time.
Our investment philosophy can be best described by stating that low valuation stocks tend to outperform high valuation stocks; companies with strong fundamentals and a high return on invested capital tend to outperform those with poor fundamentals; and stocks with positive business momentum or rising earnings tend to outperform stocks with negative momentum.
Q: How does this philosophy translate into an investment strategy?
A : The fund seeks long-term capital growth. Under normal circumstances it invests at least 80% of its net assets in a diversified portfolio consisting primarily of equity securities, such as common stocks of issuers with a market capitalization of between $1 billion and $15 billion and possessing value characteristics. We may also invest 20% of the fund’s total assets in non-U.S.-dollar-denominated securities.
Our investment process involves bottom-up research that employs a blend of quantitative and fundamental analysis. It is a consistent and repeatable process guided by our basic truths: valuation, fundamentals, and business momentum.
In terms of valuation we select stocks with lower-than-average price-to-book or price-to-earnings ratios and/or high dividend yields. Moreover, we have a risk-averse approach to protect clients’ investment principal in declining markets.
Regarding fundamentals, we focus on sales and earnings growth, profitability, liquidity, capital structure, intangible assets, return on invested capital and returns on operating assets.
As far as momentum is concerned, we look for positive earnings. We perform a trend analysis that assesses profit margins, asset turnover, working capital, and debt structure.
The foundation of our strategy is the combination of these three characteristics. It results in very risk-averse portfolios that we believe will significantly outperform over the long run.
Q: What analytical steps are involved in your research process?
A : Our process starts with a weekly screening for over 2,000 stocks with a market cap of $1 billion and higher. The screen focuses on the three characteristics already mentioned: attractive valuation, good business fundamentals, and a catalyst or momentum.
The analysts look at the list of new names every week for potential additions to the portfolio and then decide which names would be worth exploring a little further. They do deeper analysis on those stocks by meeting company management, making on-site visits, and reading press releases, prior conference call transcripts, and SEC filings to compliment their stock-specific research.
Next, the analysts derive a target price before generally presenting their ideas in one of our investment meetings. We have two meetings every week and the analysts will present to the portfolio managers. Extensive dialog follows, together with questions and answers and potential follow-up items for the analysts. At the point when we have the information we need, each portfolio manager can decide whether or not to purchase the stock for their portfolio.
Generally, a target price is set by the analyst in discussion with the portfolio managers at the time of purchase. As part of the ongoing research those target prices are updated every quarter when companies report earnings.
Q: Would you illustrate your research process with some examples?
A : Last year we bought a couple of staffing companies. These are cyclical companies that were hit very badly by the financial crisis but their valuations became extraordinarily attractive. We felt that in an economic recovery they would have significant upside.
Our perception was that fundamentally these companies were still in good shape. However we wanted to make sure that their competitive position was still intact and that their franchises were gaining market share through the downturn and still generating free cash flow even at the bottom. However, the momentum at that time was very poor, with the unemployment rate rising significantly.
Recently we have seen an inflection point in temporary hires. There has been a year-on-year improvement in hires and we believe we are seeing prospects for stabilization in the employment sector.
When we bought the stocks a year ago that certainly was not the case. We went ahead despite the fact that the near-term momentum for these companies was not positive. Yet they were doing a lot in terms of managing their business that we felt were catalysts, despite the industry-wide headwinds.
They were cutting costs, closing underperforming branches, and buying back stock - just the kind of catalysts that we look for. These companies had catalysts in place that we thought would make them long-term winners.
Q: How do you construct your portfolio?
A : We run a diversified portfolio to limit stock-specific risk. Generally, we have between 90 and 110 names in the portfolio. Our benchmark is the Russell Midcap Value Index.
The portfolio turnover ranges from 50% to 85%. It is basically a result of our philosophy of valuation, fundamentals, and business momentum. We sell stocks when any one of the three principles is violated. That is, we sell stocks based on valuation (appreciation above price target), weakening business fundamentals or reversal of catalyst.
Our sector exposure is a result of the bottom-up stock selection. Currently, the most significant over-weights in the portfolio are the technology and consumer sectors, and utilities are the heaviest under-weight.
Q: What is your view on holding cash in the fund and how do you exploit falling markets?
A : We run fully invested portfolios. The maximum cash that we are allowed to have is 5% and generally our cash levels are between 2% and 3%. We manage and limit the downside based on our philosophy and stock selection.
We do not hold cash to help us during the downturns and we do not time the market. Our clients hire us to invest in stocks and they are the ones that would make any asset allocation decision, not us.
Q: What risks do you perceive in the portfolio and how do you manage them?
A : We focus on two principal risks - loss of capital and significant shortfalls versus the benchmarks.
Preservation of capital is vital to our process. We address that issue through the use of our value discipline, namely buying stocks that are attractively valued and have limited downside risk.
As mentioned earlier, we will sell a stock when any one of the three characteristics of valuation, fundamentals and business momentum is no longer present. This approach helps to limit risk on an individual stock basis. Moreover, by running diversified portfolios we limit any stock-specific risk in terms of its impact on the overall portfolio.
We also have in place some limits on the weights of individual stocks. Our guidelines state that we should not have more than 5% exposure (at cost) to any one name. We rarely go over 3% and at this point in time our largest position is only 2%. For us, diversification is critical to risk management.
Since we are not closet indexers we do not manage to the benchmark and our sector exposures may vary dramatically from it. At the same time, we do have limits with regard to our maximum exposure in order to manage risks more effectively
