Q: What is the history of the company?
Thornburg Investment Management is an employee-owned company that was started about 25 years ago by Garrett Thornburg. With over $52 billion of assets under management the firm manages seven equity funds, nine bond funds and separate portfolios for institutions and individuals.
Q: What are the fund’s investment objectives?
The main objective of the fund is to provide investors long-term capital appreciation by investing in equity and debt securities of all types. The secondary objective is to seek some current income.
Q: What is your investment selection process?
A : The fund invests in a limited number of common stocks selected on a ‘value basis’ using traditional fundamental research. Apart from the basic value stocks, the fund also includes stocks of companies with consistent earnings and emerging franchises when these stocks are value priced.
Q: Would you elaborate on this?
As mentioned we look at three different baskets. The first one is a basket of ‘consistent earners.’ This would include those firms that have proprietary products or patented pharmaceutical products or technologies that give them the cutting edge to produce that extra and consistent earning to qualify for this basket. The second basket would be a ‘basic value’ basket. The idea here is that these are firms with cyclical businesses that have higher profit margins. Most of the selections would tend to fall in this basket. Examples would be banks, financial services providers and energy companies. The third basket consists of companies with ‘emerging franchises.’ Companies that have the potential to dominate a niche market which is growing significantly faster than the economy. So among these three baskets of selection we have a fund that has the potential to perform in any market environment since it gives us the option to pick and choose. By having a fund with that sort of flexibility, we are able to go where the value is, manage risk and still have the opportunity to outperform the market.
Q: How do you proceed with your research?
At Thornburg Investment Management, we are bottom up stock pickers. For idea generation we use our initial screens as well as information gleaned from voracious reading and discussions. Once we select an idea with promise we then start our due diligence effort. We usually review the company’s financials, and study management’s strategies for current and future goals. We listen to the various quarterly earning calls, especially those questions that are posed by the analysts on the call that give us an idea of the key issues surrounding the company. We typically review the research of the sell side analysts to get a feel for what they view as the key issues facing the company. These analysts typically have a lot of experience and we are interested in their views of the factors that could affect the company’s performance. At this point in the research process, if we still view the idea to be a good one, we usually set up a meeting or call with management to get some granularity on the key issues. These meetings are generally arranged by the Thornburg analyst who generated the idea in the first place. At this point we generally have a good idea about the stock, so we have an internal discussion with all interested analysts and portfolio managers to decide whether the position meets our investment parameters and fits into our portfolio. The final decision of picking the stock is done entirely by us, the two co-managers of the fund. By inviting all concerned persons to these meetings we are able to get a wider perspective and benefit from the knowledge of the group.
Q: Can you give us an insight into your research process?
Late in 2008 we started looking at the stock of Community Health Systems, Inc., a leading operator of general acute care hospitals in the United States. The company and its affiliates own and operate or lease a number of hospitals across 29 states in the U.S. We got interested in this group when healthcare reform impacted all healthcare stocks. When we looked at this firm they had some debts on their balance sheet. Many stocks in the healthcare systems were trading lower since they were out of favor. We knew that about 7% of the patients that walked into the Community Health Systems hospitals were uninsured and would create bad debt expense when they did not pay. The company has to offer these patients medical care even knowing they lacked the ability to pay. Interestingly, health care reform might actually benefit Community Health, because broadening the population of insured individuals could reduce the bad debt expense. At the time of our investment, we believed Community Health Systems shares were being discounted by investors due to concerns regarding their balance sheet. After taking a close look at their ability to meet interest payments and meet the loan covenants, we concluded that fears regarding leverage and liquidity were unfounded. Hospitals provide essential services and demand is only modestly impacted by the state of the economy, so after we got comfort with the state of the balance sheet, we became confident that the dramatic decline in CYH’s share price was unwarranted and we believed we had a significant investment opportunity. We bought CYH stock when it was trading at five times forward earnings and today it is trading close to 12X upwardly revised forward earnings.
Q: Would you provide another example?
Smith International, Inc is a diversified oilfield service company based in Houston. They are leading providers of drill bits and drilling fluids and also have a strong position in horizontal drilling methodology used in developing shale gas. This technology is called Measurement While Drilling or MWD. This is a system developed to perform drilling related measurements down hole and transmit the information to the surface while drilling a well. In November of last year when we were looking at the reasons for the depressed natural gas prices, we found that development of natural gas shale using horizontal wells had the capacity to produce gas at cheaper rates than traditional gas projects that utilized mostly vertical wells. Then we did additional research into the financials of this firm, listened to their earning calls, and reviewed the sell side views. We concluded that the prospects for the firm were very robust. While everything looked right about this firm we found that their stock was trading at a deep discount. When the company unexpectedly announced that they were issuing shares to raise capital to pursue an acquisition-led growth strategy, the market beat down their shares even further. But we knew that the company had a history of using an acquisition led growth strategy so we were not deterred. We used the share offering to acquire a major position in the company. Smith International also had some technologies that were tied to deep water drilling, another area where we felt activity was going to increase substantially. The company recently agreed to be acquired by Schlumberger Ltd, which had a broad product offering into which it could fold the Smith International products and services.
Q: How many holdings do you have in your portfolio?
We have 47 stocks in the portfolio today. The weighting in each basket is decided only by our stock picking methodology but at the end of the day we try to limit the weighting in the buckets of basic value and consistent earners to range from 30% to 50%. In the third bucket which is the emerging franchises we try to limit the number to be within 25% of the total. Because of this flexibility we are able to focus our investment where we see the greatest value. Focusing investment where there is value may seem obvious, but many of our competitors choose to place a higher priority on maintaining industry weights similar to the S&P 500 index. By focusing on value instead of industry weights in the benchmark, we improve our odds of delivering a higher return.
Q: What is the turnover in the portfolio?
It is anywhere from 50% to 70%. Last year because of the market volatility, we had more opportunities to put our money to work and had a 70% turnover which is the high end of our range.
Q: What are the kinds of risks that you see and how do you mitigate them?
The most important aspect to risk control is knowing what we own in the fund besides knowing the risk reward characteristics in the portfolio. We find that the consistent earners in the portfolio hold better in a tougher market environment and so the very structure of our portfolio construction gives us better risk control. We also control risk by having a disciplined sell policy. In the basic value and consistent earner baskets we sell stocks when they reach their price targets. There is no emotion involved here. In the third basket which is the emerging franchises basket we let the stocks run a little more but mostly we cut the weight by half to mitigate the risk of an upside. We sell the positions when there is fundamental deterioration in any stock. We also sell our least performing holding when we find a new idea that offers a superior value and risk reward ratio. By having these disciplined sell policies we think we are doing away with a lot of the risks. We also feel that two co-managers are better than one because we can cover a much wider area in selection as well as risk control measures.
