Q: How did the Villere Balanced Fund evolve?
We were founded in 1911 by my great-grandfather, making me the fourth generation to work at Villere & Company. We originally only managed individual accounts for high-net-worth individuals and institutions until we expanded in September 1999, launching our first mutual fund, followed by a second in May 2013.
Q: What differentiates your fund from its peers?
A typical balanced fund has large-cap value and blend, with about 150 to 200 holdings, where the top five holdings are well known companies like Apple, Microsoft and Chevron. Our fund has small and mid-cap growth comprising reasonably priced securities. These companies are earlier in their growth cycle with the potential to make money currently and into the future, versus larger, slower growth dividend paying companies.
Our balanced fund generally has between 60% and 70% in stocks and 25% to 40% in bonds. We offer active management, concentrating on just 20 to 25 securities based on our best ideas, rather than diversifying into every sector, globally. There’s so much concentration on index funds these days. Instead, we target a five- to seven-year period, a full market cycle, where we can potentially deliver better returns than that of an index.
Right now, the fund’s assets total about $230 million, but we buy the same stocks for the fund as for the separately managed accounts, so, in total, our assets are north of $2.0 billion. By only buying 20 to 25 companies, we take a substantive position in each, giving us a competitive advantage. As we are often a top-10 shareholder, these companies take our calls, permit scheduled visits, and answer our questions.
Q: What core beliefs drive your investment philosophy?
Other than being small- and mid cap-concentrated, we have a bottom-up-oriented process. As stock pickers, we love companies featuring reasonable/low/no debt on the balance sheet, and companies with strong free cash flow characteristics so that if revenue falls, they have sufficient cash to make acquisitions, pay dividends and buy back stock.
We also want to see a low price-to-earnings (P/E) ratio relative to its growth profile, particularly P/E to growth that’s less than or close to 1, as opposed to stocks with high price-to-earnings. We seek a low P/E to growth before buying something.
We look for companies growing 15% or 20%, available at a multiple of 10, 12 or 13 times, that we can hold for five or six years. We also love companies that dominate a particular industry, ideally with high barriers to entry that make it difficult for other companies to compete. While we love small and mid caps as opposed to larger cap, sometimes we might stray larger if it’s temporarily out of favor, making it inexpensive, in which case we will try to take advantage of market volatility or other short-term market dislocations.
Q: Why do you prefer small cap versus large cap?
Historically, when comparing returns on a basket of small caps versus large caps, small caps tend to outperform by about 2.5% over long periods because the slight increase in risk offers slightly more reward. Visa Inc. is the largest company we own. When the Durbin Amendment came about, it was under pressure for about a year, falling to about 14 times earnings from its norm of trading at about 19 or 20 times earnings, and growing at 20%, so we took a position. We’re still holding it, but it’s getting a bit expensive now.
In general, smaller companies can grow much faster. We like to buy companies with a long runway ahead of them as opposed to larger, more mature companies where growth is slowing.
Q: How does your philosophy translate into your investment process?
Let’s say there are 3,500 U.S. companies in the investable universe. We narrow that down to those that are growing quickly, have little debt, and reasonable valuations. That gets us down to about 500 companies. We begin researching, ideally meeting management teams, and gauging the competitive factors, which pares our list to about 100 companies.
Then we look at all the characteristics I mentioned, ignoring macro factors such as interest rates, oil prices, or the direction of the dollar, focusing on individual companies and their earnings profile over the next three to five years. We don’t care what the next quarter or the next year looks like. We seek long-term potential.
We visit these businesses to better understand who’s managing the company and assess their track record in order to invest for the long term. We think of ourselves as owners of these businesses.
Q: Can you cite an example of your due diligence process?
We like Axon Enterprise Inc. right now, which develops non-lethal weapons for the police and military. The weapons business is typically a good cash generator, but we were particularly taken by their business model, which is essentially a SaaS (software as a service) model, providing body-worn cameras to police departments all over the country.
Axon doesn’t make money on the camera. Instead, users pay a monthly fee per camera to download the digital content after every shift onto Axon’s website, Evidence.com, providing a solid, steady cash flow. Part of our bottom-up research included talking to their clients about the value of the service, even meeting with some local police chiefs here in New Orleans. Behavior is much better on both sides of the badge, we were told, by both officer and perpetrator. That gave us the confidence to invest in the business. Many police departments have begun to use their cameras and the need continues to grow.
Q: How do you decide what position size to take?
We lean toward about a 3.5% position, between $75 million and $90 million, depending on the bond allocation in each separately managed account. But we don’t want to move the market, so we tend to buy over about a 20-day period, staying below 20% of the daily volume of that particular business. We find this allocation to be more meaningful. If a stock works, it can have an actual impact on the whole portfolio. Most of our competitors take such small position in each company that one individual stock doesn’t really move the needle.
Q: Would you share another example of your research process?
We bought POOLCORP, a local company, originally when they went public in 1996. What we loved about the business was that, competitively, they are as big as their largest 50 competitors combined. The majority of swimming pool owners in the U.S. get their chlorine and maintenance and repair supplies from POOLCORP, making it the largest distributor of swimming pool products in the country.
The preponderance of their revenue derives from repair and maintenance, because people generally won’t let their pools turn green or black from algae, so it’s a great investment for us. They continue to grow nicely, adding related, often green businesses that steer customers toward having their whole yard attended to by POOLCORP, including gardening and lighting. It’s consistent and has been growing probably 18% to 20% for the better part of 20 years.
Q: Have major big-box and online players like Walmart and Amazon impacted POOLCORP’s business?
This was a big concern maybe 10 years ago, but while they said Amazon was one of their biggest competitors, they’re also one of their biggest customers—they supply Amazon’s demand. So one way or another, even if a customer buys from Walmart or Amazon, POOLCORP has their hand in it.
Notably, there are a lot of things that people won’t buy through Amazon—they’d rather go to their pool company. Even the do-it-yourselfers who repair and re-plaster their swimming pools end up sourcing supplies from their pool company. So, while there’s some part of their business that might have some margin exposure, e.g., chlorine, in general it hasn’t really impacted them and arguably helped their business by expanding its customer base.
Q: Do you have any specific portfolio construction strategy?
In stocks, if we’re particularly optimistic about the market, our holdings are closer to 70%, down to 60% if we’re pessimistic. Last summer, a lot of our stocks exceeded where we thought their valuation should be, so we raised cash to about 12%, but then invested about 50% of it between Christmas Eve and New Year’s, when the market sold off pretty sharply.
We’re strictly valuation driven, so when stocks are cheap, we’ll invest more money, and when they’re expensive, we’ll take profits and pare back our stock weightings.
Q: Do you have a certain band that you like to stay within in your equity allocation?
We state in our prospectus that we basically remain above 60%. We never try to time the market. In general, when things are expensive, we sell and take advantage of strength, and when things are cheap, we take advantage of weakness, staying within that band of 60% to 70%. I would say about 61% is the lowest we’ve been.
Q: What are your bond investment guidelines?
We stay within 25% to 40% in fixed income. We don’t buy U.S. Treasuries, as they’re way too safe. We’d rather take some risk and get some reward, and don’t mind taking some risk when it is a risk we know we are taking. We’ll buy 10% of our fixed-income portfolio in non-investment grade or high-yield bonds to try to improve the yield a little bit.
For example, if we have 25% in fixed income, we might put 2.5% in non-investment grade bonds. We tend to stay shorter in duration than typical funds—basically a three-to-four-year duration. We don’t have too much exposure to fixed income generally, preferring to stay shorter to protect against rising interest rates.
Q: Do you have any benchmark for the fund? What is your portfolio turnover?
We tend to use the Bloomberg Barclays US Intermediate Govt/Credit Bond Index as our benchmark, with a six- to seven-year duration. For the entire fund, we use the Lipper Balanced Fund Index, because it consists completely of balanced funds. We show the S&P 500 Index, but it’s not a fair comparison because it’s 100% equities and we have around 25% to 30% in bonds.
Turnover tends to be about five years, so about 20% annually, because we buy for the long run in the stock portfolio. We hold bonds to maturity and are not traders.
Q: Is there a time when your stock analysis leads you to a corporate bond opportunity as well?
Yes. For example, one of the bonds that we hold—we own the stock and the bond—is LKQ Corp., a global distributor of vehicle parts, which, although lower quality, we like a lot. We visit management to understand what they’re trying to do and take advantage of a good opportunity that can deliver a little bit more yield even though it’s a bit riskier than the average corporate bond.
When someone wrecks their car, the first thing they do is call their insurance company or body shop, where the fine print says they use like-in-kind parts, which are 20% to 40% cheaper, the type that LKQ supplies, not new or OEM parts. Their business cannot be replicated, making it almost impossible to compete with them over the long run. We like how they dominate their niche in the marketplace. So, not only do we like the stock but we think the bonds will pay us an outsized return on the fixed income side.
Q: How do you define and manage risk?
One thing we pay attention to is when a stock gets overvalued. We try to control risk by assessing our companies continuously. For example, if POOLCORP got into something like the auto business, it would raise red flags and we would probably exit.
If there is a period of overvaluations in the market, we can tolerate underperforming for six to nine months, taking profits and getting out of the way as things get overheated and overdone on the upside. Monitoring our businesses closely, and understanding what’s going on within each one, gives us confidence in our portfolio.
