Q: John tell us about Wentworth’s Small Cap Portfolios:
A: The small capitalization product evolved out of our large capitalization efforts to identify companies with high reinvestment rates selling at a reasonable multiple of future earnings. The firm uses a four-man approach with each of the four managers managing a fourth of the assets. o Why use a four-man approach? Mr. Koloszi: We felt it provided enhanced diversification in an inherently volatile asset class, as well as allowing each of the four of us to focus on a smaller number of companies, thereby improving our understanding of the businesses we invest in. Primary research emphasizing fundamentals is our investment edge. The multi-manager concept has in effect smoothed returns, and promoted a healthy competition among the four of us, while providing our clients top-notch returns.
Q: What do you see for the future of small-cap investing?
A: Well given the market’s recent decline, there are a lot more small-cap stocks now than there were a few months ago. In terms of relative valuation, small companies are much cheaper than the large cap names, near record levels according to the quantitative data we compile. In addition, the selling may be overdone in selected areas especially given the underlying growth rates for many of these companies. For the patient investor, this is a great buying opportunity. o
Q: Describe your approach to small-cap stock selection:
A: Wentworth, Hauser & Violich has a proven record of identifying high quality companies with strong management, solid fundamentals and a proprietary position in the marketplace they serve. The focus is on future revenues and earnings with a multiple equal to or less than the Russell 2000. Typically the company has a product or service not well known or well understood by the street, with little or no analytical coverage from the major firms. When in time the company gets discovered, we’re well rewarded for being early. This also tends to keep portfolio turnover fairly modest as well, which is important to taxable investors. While each of the four of us can invest in any industry group or sector, portfolio concentration limits of 7.5% per stock and 33% per sector are imposed to ensure adequate diversification.
|Phillip J. Fox – Managing Director & Portfolio Manager Mr. Fox graduated from Lafayette College in 1963 and earned his MBA from Harvard University in 1965. From 1966 through 1985 he worked in the nascent field of investment consulting. In 1985 he joined Crocker Investment Management Corporation as a Senior Vice President. He joined Wentworth, Hauser & Violich in 1986, and was awarded his CFA and CIC designations in 1991. Phil provides oversight to the small-capitalization product as well as the Expanded Value portfolios with over $1 billion in assets.
Q: Phil, tell us about the Expanded Value Portfolio:
A: Expanded Value follows the concept of relative reinvestment rate that Kurt Hauser & Paul Violich developed over the past thirty years. Expanded Value incorporates six measures of value: price-to-book, price-to-cash-flow, price-to-earnings, price-to-liquidation, price-to-sales, and the relative value to other companies in its peer group. In addition, we’ve patented a process of analyzing other Value Investors holdings to generate additional ideas for our analysts.
Q: How do you define “Value Investing”?
A: The concept of value investing has evolved over the years, as have the equity markets. Traditionally value investors focused on the asset values inherent in a business – cash, inventories, plant & equipment, real estate holding & dividends. In this era, called the information age as by 2005 over 50% of the economy will be related to information technology, plant & equipment is less important than it was in the industrial age. Dividends also have become less meaningful to investors as the double taxation has resulted in fewer increases over the past decade. Value investing today focuses on the value added a business could generate across its offerings of goods and services whether it be in healthcare, manufacturing, retail, services or technology. Corporate raiders in the 1980’s unlocked many sources of value in corporate America as they bought and then broke up and sold selected businesses. Strategic investors also shaped the value concept with investors like Warren Buffet focusing on the concept of branding as being an inherent asset of the business. Today many companies are attempting to leverage the brand across the broadband to bridge the gap between “Bricks & Clicks”. Many factors define value today, and Wentworth, Hauser & Violich uses the collective experience of our twenty professionals to identify quality companies selling at reasonable prices with solid revenues and earnings.
Q: Describe your Investment Process:
A: Every Monday the firm meets to discuss the economic outlook and analyze the data coming out of Washington. Interest rates and the fixed income area are discussed next by our fixed income team. The equity markets are then reviewed with a primary universe list of approximately 300 companies. Reinvestment rates, growth rates and price-earnings multiples are all analyzed to further refine the portfolio candidates. Each analyst presents his or her ideas to the stock selection committee for approval. The Expanded Value Portfolio of between thirty-five and forty-five equities gets created in this way.
Q: Describe your Sell Discipline:
A: While we typically have a long holding period for our names, with an average annual turnover of 20%, there are several reasons we sell a security. The easiest sale is if a stock becomes overvalued or exceeds our analyst’s price target, the holding is then sold. The more difficult decision is when to sell a company that is performing poorly. Earnings shortfalls cause us great concern, but do not automatically result in elimination. The fundamental deterioration of a company or an industry also will likely result in a holding being eliminated. Finally, if there is a change in senior management, it can trigger a sale if there is a material change in the outlook for the business. We do not believe in an automatic rigid sell discipline, we do have procedures in place to limit the losses. Every holding down 10% from our cost is reviewed for fundamental deterioration. While this in and of itself does not prevent losses, it ensures that we address the issues that stumble as quickly as possible.
|Richard K. Hirayama – Senior Portfolio Manager & Analyst
Mr. Hirayama received a BA from the University of California, Berkeley in 1968, and his MBA in 1969. Mr. Hirayama was a computer research analyst with the Bank of America Trust Department and BA Investment Management from 1969 to 1981. He became a portfolio manager and security analyst at BAIMCO in 1982, and Associated Capital Investors in 1988. He joined Wentworth, Hauser & Violich in 1990 and began managing the international portfolio in 1995. Over the past five years, his performance results rank him among the top five percent of all managers in the nation.
Q: Describe your investment Process:
A: Wentworth, Hauser & Violich uses a sector-rotation approach in managing its International portfolios. Our firm sees international investing a little differently than other firms in that country, and currency are less important than the sector you’re investing in. Our portfolios focus on those economic sectors around the world exhibiting the best prospect for sustainable growth. Using exclusively ADR’s (American Depository Receipts), we select those companies who are the dominant players in their industries, with proprietary products and technology, and top quality management.
Q: Why do you use ADR’s?
A: ADR’s are traded in this country, and typically provide us better liquidity. In addition, the disclosure rules are generally more stringent in these securities than with ordinary shares, which trade on foreign exchanges. It also virtually eliminates any potential trading and settlement problems associated with investing overseas. It also means the shares are dollar-denominated which can reduce the currency risk.
Q: To what do you attribute your Stellar Performance?
A: Our proprietary sector-rotation valuation model has really identified areas to overweight and underweight when valuations become distorted. The tendency for many managers is to focus on the individual stocks, and not see the forest from the trees. In hindsight, for example, many managers now look back on last year’s Internet stock craze as a speculative bubble that burst. Very few people sold technology in the midst of the mania, as all the analysts were very bullish and greed had overtaken fear. Our sector relative valuation work told us that telecommunications was overvalued in Q11 200, and we sold virtually all our France Telecom, Deustche Telecom, NTT/DoComo and Telefonica we owned. The cash was reinvested into the drug and energy sectors, which have held up very well in this market environment. We continue to monitor these broad secular trends for change, and will move quickly to implement the new positions as it becomes appropriate.
Q: Is the Technology sector attractive yet?
A: Now that many stocks in the technology & telecommunications sector are down 35% to 50%, it is beginning to look more attractive. There are serious concerns about the level of capital spending on technology going forward, which may lengthen the correction. We are selectively looking at semiconductors, telecommunication and data storage to name a few areas where there are jewels among the dot.com carnage. Stock selection is key in these sectors as technology evolves very quickly.
Q: What do you see in the future of international investing?
A: It used to be that asset allocation drove superior returns, and reduced risk. Given the surge in global liquidity, just having assets in foreign markets added alpha. Then country analysis became the most important factor in international investing, and pioneers like John Templeton correctly foresaw the effect these capital inflows would have on many then-emerging markets. As the global capital markets matured, these markets became more efficient, and correlations between the U.S. markets and foreign markets increased. Today the rise of the Internet has created “New Economy” companies without borders, and really changed the way stocks trade. Trade barriers are down, and global corporate titans battle it out worldwide for market share, meaning that sector selection becomes more important than country selection. We expect that correlations between domestic and foreign markets will continue to rise, furthering the trend toward sector selection. Stock selection also adds enormous value as the competitive nature of business rewards the leaders and punishes the laggards in virtually every industry. Consolidation in many industries such as the automotive, energy, publishing, retail, telecommunications will continue, and by investing in the best and the brightest, you increase your chances for success. Another major trend shaping international investing is the increasing ownership of equities by individuals around the world. The surge in global capitalism has seen many new investors come to the markets. Ten years ago Chinese and Indian investors had very little in the way of net worth invested in stocks. Ten years from now that number will be very significant. Privatization in Japan will allow for self-directed retirement plans in the year ahead, and investors in France, Germany and Italy all have seen the light and begun to invest in equities. In the United States stock ownership is at record levels, and I expect this trend to also take hold overseas. All these trends are positive for investing overseas.
Q: Any final thoughts for investors about the market?
A: While volatility is likely to continue, a patient investor will be rewarded by focusing on quality.