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   Interview

    Guest Interview:

   Snow Capital Management LP

    2000 Georgetowne Drive, Suite 200
    Sewickley,PA 15143

    Telephone: 724-934-5800
    Fax: 724-934-5855
    E-mail: data@snowcm.com

 

    Interview Quarter: 3Q2003

 Richard Richard

 ------

 
Q: Richard, what events in your career led to your founding Snow Capital Management?

A: Not long after my graduation from business school in 1980 my family sold a business which we had built from scratch during the sixties and seventies. The sale yielded a significant amount of money and for the first time my family had substantial assets that required professional management. I had a background in accounting and always had a passion for equity research. As a result my family decided that I was as qualified as anyone to manage our portfolio. During the next several years I developed and implemented a process that, fortunately, enabled me to substantially outperform the market on a consistent basis while assuming, I believe, significantly lower risk.

Q: At what point did you decide to manage more than just your family’s investment funds?

A: There were several advisors to the family, attorneys and accountants, who were privy to the type of performance I was achieving with the family’s investments. By the early nineties some of these people began to approach me about managing money for them and some of their clients. Being somewhat naïve I literally called up the SEC in 1992 and asked them what I needed to do in order to manage other people’s money. This led to becoming a Registered Investment Advisor. Then I began to take on some outside clients but strictly on a referral basis. I never made any kind of proactive attempt to market my service until 2001. At that time my firm had grown asset wise to the point where I needed to build an organization and marketing became a part of that infrastructure.

Q: What is your overall investment strategy?

A: I consider us to be a classic value shop. We have been described as both “deep value” and “contrarian”. I would not necessarily disagree with either assessment. We try to find companies that have been oversold by the masses in reaction to some negative event or development that is likely to be temporary in nature and ultimately correctable, if handled well by management. If we are comfortable with the company’s capitalization structure and the management’s plan for transitioning the company through whatever difficulty it is experiencing and returning the stock to a proper valuation level, it becomes a potential buy for our portfolio. We try to determine normalized earnings and assign a normalized PE to the stock. At the end of the day we are really looking for two things, increased earnings and of equal, if not greater importance, PE ratio expansion. We feel the latter is as much a function of psychology as it is anything else. We try to identify situations where some catalyst exists that are likely to change investor perception of the stock and result in valuation expansion.

Q: Please tell us a little bit about your performance?

A: My audited track record dates back to January of 1992. Since that time we have beaten the S&P 500 Index, on average, by approximately 1000 basis points annually. We feel that is significant value added especially considering we have taken, we believe, below average risk in achieving those returns. Going forward, we think our process can continue to yield substantial out-performance in a prudent and tax efficient fashion.

Q: What influenced you to take this particular investment approach versus others?

A: When I initially took control of my family’s investment portfolio my charge was to protect the principal. Growing the assets in a prudent fashion is almost a secondary objective. It’s a close second but second nonetheless. As a result the value style of investing intuitively seemed like the most prudent way to grow capital in the equity market without taking undue risk. This principle of capital preservation still drives the process at our firm some twenty years later.

Q: Please tell us a little bit about your performance?

A: My audited track record dates back to January of 1992. Since that time we have beaten the S&P 500 Index, on average, by approximately 1000 basis points annually. We feel that is significant value added especially considering we have taken, we believe, below average risk in achieving those returns. Going forward, we think our process can continue to yield substantial out-performance in a prudent and tax efficient fashion.

Q: How many stocks do you screen and how many end up on your “buy” list?

A: At any given time we are probably following upwards of 100 stocks. We tend to own between 30 and 40. The balance tends to be evenly split between stocks we have owned in the past and are continuing to monitor for possible redeployment to the portfolio as well as brand new companies that we are following for potential purchase.

Q: What goes into your fundamental research?

A: Our entire process is driven by a strong focus on the balance sheet. We never invest our client’s money in any overly leveraged companies. We look for strong, free cash flow, low relative debt to asset ratios, high tangible book value, and solid sales growth among other metrics. While we focus on the published financial reports, there are other important facets of the research process. We talk to management frequently and participate in all conference calls. We make extensive use of a well-developed diverse network of industry analysts and executives, some of who are our clients, which provides indispensable macro information and industry background. We also frequently talk with key customers, suppliers and even competitors to get as good a sense as possible as to how the company is positioned. The whole idea is to find companies that not only have a sound plan for repositioning themselves but also the financial wherewithal to successfully implement the plan. Focusing on the balance sheet has allowed us to identify such opportunities while limiting the downside risk when the transition fails to go as anticipated.

Q: Are you able to find “ out-of-favor” stocks in all market cycles?

A: Typically yes. While it is easier in some environments, we can always find 30 to 40 companies that are worth owning. As stock pickers we adhere to a strict bottom up approach and tend not to become consumed with what cycle the overall market happens to be in at any given point in time. While we obviously pay attention to the macro environment, it does not drive the day-to-day research and portfolio construction process at our firm. We would buy the same 30 plus stocks regardless of where we think the S&P or the Russell indices will be three to six months from now. As a result we stay 90% plus invested at all times. Again we are stock pickers not market timers. Sticking to this discipline has been responsible for our long-term success.

Q: How long are you willing to wait for a stock to recover that meets your criteria of being “under-valued”?

A: We tend to take a fairly long-term view of our investments. This is a byproduct of the fact the majority of the assets we manage are in taxable accounts. As a result we actively manage for tax efficiency and we have extremely low portfolio turnover. As long as there is no balance sheet deterioration and all the factors that led us to buy the security in the first place remain valid we are prepared to wait a reasonable amount of time for the stock to reach what we consider to be a proper valuation level. I have no magic time limit in mind when we buy a stock but it is not unusual for us to stay with a position for over three years. Some situations take longer to turn around than others.

Q: Do you do all your own research or do you also use outside sources?

A: We do all our own research. While we certainly have access to all the street research we could possibly want, we tend to use it as a contrary indicator. Outside research can be useful in giving us background information on certain sectors and industries, but we do all company specific research ourselves. This is not to say that there is no value in outside research. These industry analysts are very smart people and in most cases they know more about the various industries we invest in than we will ever know, but many times they are so focused that they cannot see the “forest through the trees”, so to speak. The problem with street research, as it applies to individual stocks, is that most analysts want to wait until all the proverbial planets are aligned before putting out a buy recommendation. At that point it’s too late. Most of the upside is already priced into the stock. The trick is to buy good companies when nobody wants them. At that point they only have one way to go. As I said before, we employ a number of fact-finding exercises beyond just the published financials; but honestly, most of what we need to know is right in the 10K, and 10Q’s.

Q: Does your approach work only for individual stocks or do you ever find whole sectors that appear to be good values?

A: While we don’t really make sector bets per se, you will find certain recurring themes throughout the portfolio; however, this is not by design. As I said earlier, this is entirely a bottom up process. Nothing we do is top down. However, what typically happens is that as we research a particular stock that comes across out radar screen we will also take a look at some of the company’s peers in that industry group. Often times one or two of those names will become attractive to us as value plays in their own right and end up on our buy list. For example, Archer Daniels Midland is a stock we own and have owned for some time. During the process of researching ADM we looked at several other agriculturally oriented stocks and ended up owning a large fertilizer producer called Agrium, another agricultural conglomerate called Bungee Ltd and CNH Global, a manufacturer of heavy farm equipment, among other things. So as a result of looking at one company we ended up with what could be called a sector play on the recovery of the farm economy. However, it is important to note that we did not wake up one morning and decide we needed to put a certain percentage of our portfolio in agriculture, it happened as a by product of bottom up stock picking. We have made significant investments in other sectors such as financial services and energy, among others, in much the same fashion.

Q: How do you construct portfolios to achieve your desired diversification?

A: As previously discussed, we always own approximately 35 stocks. We try to spread these out evenly over at least a dozen relatively unrelated industry groups. While some sectors will be more heavily weighted than others, we will never allow any one-industry group to become more than 25% of the portfolio. In reality a 15% to 20% exposure to any one sector is pretty high for us. For example, right now our largest industry allocation is in financial services and that is currently about 14% of the portfolio. Our second largest is in the agricultural sector and that is currently less that 12%. As far as individual securities are concerned, we try to give each position an equal weighting of approximately 3% when we initially construct a portfolio. There are two exceptions to this rule. If we happen to like a stock that has a market cap under $250 million or a stock price under $5, we will only take a half position or approximately 1.5%. This is due to the inherent price volatility of these kinds of stocks, which at any given time typically comprise 3 or 4 positions in the overall portfolio. So each stock typically starts out as a 3% position. We really do not like to let any one position grow to more than 6% or 7% of the overall portfolio. When this happens we will either get out of the position or, more typically, pair it back to a 3% or 4% position, if we still like the stock. The only time we would hesitate to do this is if it would trigger a short-term capital gain in a taxable account.

Q: What makes your approach different from other value style managers?

A: I began this firm as a vehicle for managing my own money and as we sit here today, I still manage my client’s money in the same way. I still view our primary responsibility as preservation of capital. I think many other managers are worried primarily with relative performance while our focus in on absolute return. Also, we are not disciples of the style box religion that has been created over the past two decades. It has always seemed counter-intuitive to me, in managing my family’s investment portfolio, to force myself to stay within the parameters of some market cap style box. I believe I should be able to purchase value wherever my process takes me, whether that is in the large, mid, small or even micro cap marketplace. Therefore, we run what is truly a multi-cap or all cap portfolios. To not buy a stock that I have researched and feel to be an excellent value because it only has a $4 billion market cap as opposed to a $5 billion market cap seems silly to me. I believe that it is this kind of flexibility that has enabled us to extract the significant alpha from the market and enjoy the success we have over all these years. So, to sum up, I think the focus on bottom up stock picking, absolute as opposed to relative performance and the all cap approach to value investing is what really sets us apart.

Q: Explain what conditions would lead you to sell a company you hold?

A: We rarely catch the bottom or the top of a price cycle nor are we trying to. There is enough room in the middle to make money. Ideally, when one of our stocks reaches a level that we consider to be normalized in terms of earnings and valuation we will sell. While we generally have a price target when we initially buy a stock, it is not a static number. If the story gets even better as we monitor it, the price will be increased. Also, as mentioned in one of your last questions, we will certainly sell a position if it becomes too large a component of the portfolio. On the downside, we are loath to sell a stock if there has been no balance sheet deterioration. As value investors we are typically buying stock in companies that are experiencing some type of difficulty, which has caused most of the investment community to sell in droves thus making the price attractive to us. When you buy a stock in that type of environment, it is not usual for it to continue to drop after we establish our initial position. In fact some of our most profitable investments in the past were stocks that continued to drop, sometimes 5%, 10% or even 15% after we initially bought them. If this occurs in a taxable account we will occasionally double up on the stock and sell the initial position 31 days later to take advantage of the tax loss and create a lower cost basis. We have recently instituted what we call the “Enron rule”, while we are fortunate enough to not have owned Enron we did learn a valuable lesson. If any of the stocks drop 30% below our average cost basis, we will automatically sell, regardless of whether we still like it. Once sold, the stock cannot be reviewed for repositioning for at least 90 days. We view this as a safeguard against fraud.

Q: Who are the other principals in your firm and what are their job functions and backgrounds?

A: Joshua Schachter is my Research Analyst. He is responsible for helping with idea generation and doing initial background research on companies we are considering buying as well as ongoing portfolio monitoring. We have recently made a large investment in technology to help him in these tasks. David Williams is the Chief Operating Officer and handles the day-to-day operations of the firm from a managerial perspective. Dan McNichol is the Director of Sales and Marketing and is responsible for business development as well as the overall marketing of the firm. He focuses on developing our relationships with financial advisors, consultants and the broker dealer community. David Mathews is the Director of Institutional Sales and concentrates on developing our relationships within the pension fund consultant and plan sponsor marketplace. In addition to these four gentlemen, who have a combined 65 years of investment experience, we have four other support people who perform various trading, portfolio administration and other back office functions.

Q: How were you able to do so well during the late nineties when most “value” managers under-performed the averages?

A: First of all, as I have previously stated I believe that our all cap approach is largely responsible for our out-performance since I started the firm. Also, we don’t look at value as an industry specific issue, as I believe many value investors do. In other words many value managers would look at technology, for example, and say a as group no tech stock can be a part of a value portfolio because of the inherent over-valued state of the whole sector. We do not take this approach. We will buy a stock in any sector or industry group if our process identifies it as a good value opportunity. Another important difference is that we view value on a relative basis where as many of our peers approach it from an absolute point of view. If a stock deserves a valuation of 30 times normalized earnings and it is trading at 15 times that potentially becomes an attractive buy for our portfolio. Many value investors will not touch a stock if it is not at or below a certain multiple, regardless of the circumstances.

Q: What is your target market for new accounts?

A: We are taking a two-pronged approach to developing new accounts. We have built the business over the past by concentrating on high net worth individuals and wealthy families. We are continuing to focus on this group primarily by working with financial advisors and consultants. We have developed distribution arrangements with several major brokerage firms, which allow their reps to utilize Snow Capital for their clients through the firm’s wrap program. This is becoming a significant source of new assets for us. We have also begun to develop new business on the institutional side primarily through pension fund consultants and in some cases directly with plan sponsors themselves. While we do not strictly adhere to the style box discipline that is popular with most large institutions, we are finding that there are many consultants and sponsors who are more concerned with alpha generation and really find our approach quite interesting. We really believe this will become the dominant market for us going forward. In addition, family office, foundations and endowments are significant to us.

Q: Where would you like to see your firm in five years? When we developed our initial business plan my partners and I agreed on one thing, we do not want A: this firm to get too big from an organizational point of view. We have no desire to end up managing tens of billions of dollars for thousands of people. Nor do we have any desire to have hundreds of employees. Organizationally we really hope to have no more than one to two dozen people and we currently have nine. We view our growth objective more from a relationship point of view than a total asset point of view. We see somewhere around two hundred client relationships as a manageable number. Now remember I am talking about relationships not accounts. One client relationship with a consultant or advisor could yield dozens of accounts, but we view that intermediary as our client. In most cases we have no contact at all with the actual end user. To answer your specific question, in five years I believe it is reasonable to say that we will be approaching the billion-dollar mark in terms of assets under management. We currently are just over $300 million. I would be happy with that progress.
 
 
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