Cindy Starke has been a portfolio manager at EULAV Asset Management (“EAM”) since May 2014. Ms. Starke joined EAM with nearly 20 years of mid and large cap gro +
Cindy Starke has been a portfolio manager at EULAV Asset Management (“EAM”) since May 2014. Ms. Starke joined EAM with nearly 20 years of mid and large cap gro +
Liane Rosenberg has been a fixed income portfolio manager at EULAV Asset Management (“EAM”) since 2009. Ms. Rosenberg came to EAM with more than 20 years of ex +
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Q: Could you give us some background information on the fund?
In February of 2018, the Value Line Income and Growth Fund was renamed the Value Line Capital Appreciation Fund. It currently has $435 million in net assets. Liane Rosenberg, who has been on the fund since 2011, manages the fixed-income portion of the portfolio. Cindy Starke joined the fund in 2014 and manages the equity portion of the fund. At the end of 2017, the asset allocation of the fund was approximately 85% in equities and 15% in fixed income and cash.
Q: What core beliefs drive your investment philosophy?
With equities, our goal is to create superior longer-term capital appreciation for investors through longer-term ownership in a diverse group of leading growth companies. We believe that sales and earnings growth are the primary drivers of share prices over the longer term. Overall, we target sales growth of 10% and earnings growth of 15% on average for companies in the Fund.
On the fixed-income side, it is primarily about relative value. While we actively manage the duration of the Fund, taking interest rate risk is not our primary way of adding value. Although we take some bets in placement on the yield curve depending on our interest rate forecast, our returns and outperformance of the index come through sector and individual security selection. We had a large corporate overweight relative to our index and a similar underweight in US Treasuries for the last few years. This year had seen a reduction in overall corporate exposure and increases in Treasuries as we dialed back our risk exposure in 2018.
Also, we believe in diversification. Our fixed-income process begins with a top-down approach and an economic overview. We take into account global trends and what are central banks are doing or are likely to do. So, we start with a broad economic conviction and work from there.
Q: What is your investment process on the equity side of the portfolio?
On the equity side, our research process is bottom-up. We look to own high-quality growth companies, that we believe can grow both their sales and earnings at a faster pace than the market and their peers.
As far as finding these great growth companies, we have a multi-step research process that helps us identify and analyze these companies. Our process begins with idea generation, then transitions to fundamental analysis on the companies that have attractive growth businesses and warrant additional research, then ends with our decision making.
The first step is idea generation and there are a variety of ways new ideas come to us. One tool we regularly use is quantitative screening. Every two weeks we look for companies that are consistently beating expectations and are growing faster than the market and their peers. Another tool we use is Value Line’s Timeliness Ranking, which is updated on a weekly basis and ranks approximately 1,700 stocks relative to each other for expected price performance over the next 6-12 months. Stocks are ranked on a scale of 1 to 5, with ones expected to be the strongest relative performers and fives expected to be the weakest.
Importantly, the idea generation process involves us constantly reading, listening and learning about new companies, longer-term industry trends and changes in consumers buying behavior. This includes us going to conferences, speaking to analysts and management teams. We listen to all our companies’ conference calls as well as to those of their competitors. We find it helpful to understand how they are spending and investing their money as this often gives us insights on other industries and companies for us to potentially invest in.
During the fundamental analysis process, we view sustainable sales and earnings growth as the most important factors. In general, we like to see sales growth of at least 10% and earnings growth of 15% over the next few years. We strive to own companies with strong balance sheets, led by visionary management teams, and are not dependent on the economy to succeed. Overall, we are looking for unique growth businesses, preferably dominant global brandsand businesses that operate in industries have high barriers to entry or a product/service with a competitive advantage or differentiation. When we take into account all of these fundamental factors, there aren’t too many companies we feel compelled to own.
The final step is decision making. If we believe that we have found an idea that meets our criteria and we want to buy it, then we decide if we should sell or reduce our exposure somewhere else. If we like the company but have some concerns, we may decide to watch it for several quarters. Because we start with the intention of owning these businesses for the long term, we are not concerned about waiting a quarter. We are never forced to buy anything.
Q: Would you describe your process from the standpoint of fixed income?
We also take a long-term view in fixed income, but we ask different questions. We examine how the management has treated the bondholder relative to the shareholder. We want to see if the company is returning cash back to the shareholders and how stable the credit profile has been. It is also important which sectors will do well in the current environment and in the future economic backdrop.
Now we are looking at companies that will do well in the current rising interest rate scenario. Generally, corporates have done very well for us in both investment grade and high yield. Unlike our index, we have a modest high-yield presence that has generally been a source of alpha.
When researching individual companies, we go to conferences and read credit reports from independent credit analysts as well as from Street analysts. Increased M&A activity can be a cause for concern and a close watch is kept on these credits. We don’t trade heavily as we try to keep turnover low and costs down. We prefer to we give these credits time to run.
Q: How do you generate ideas on the fixed-income side?
On the bond side, many of the ideas are generated by the technicals in the market. When new bonds and companies come to the market, we start to follow them. Once we become interested in a name, we analyze spreads, relative value, and overall credit metrics. We may like a name but decide not to own it if deemed too expensive. We may look for a more attractive entry point when the bond’s relative value improves. Overall, the decision-making process is driven by both fundamental and technical factors.
Q: Could you give us some examples of holdings to illustrate your research process?
A good example of our Equity research process is GrubHub, the leading US online and mobile food-ordering and delivery company. We have owned the company since a pullback in their share price in 2015 and it has been one of the top performers in the Fund over the past few years. Initially, we found the company through our quantitative screening process while we were looking for companies that were projected to grow sales and earnings faster than the market. It was nice to see GrubHub make the list, as we were already frequent users and big fans of their Seamless branded service.
At the time, GrubHub (GRUB) was a small-cap company, and while we own mainly large cap names, we were attracted to their early market leading position in the fast-growing food ordering and delivery market. GrubHub has transformed this market through organic growth and acquisitions and now has over 80,000 restaurant partners in more than 1600 U.S. cities and over 14 million users.
During our fundamental research process on GRUB, it revealed a business that we believed wasn’t easy to execute and one in which scale, trust, and a significant first mover advantage were all important competitive advantages. GRUB has already established a brand name that helps restaurants reach more customers and drive more sales and has a simple and trust worthy interface for consumers that made ordering food to go seamless. All of these factors, combined with an impressive revenue and earnings growth outlook, led us to initiate a position.
GrubHub is the kind of company we like to own – it has a brand that consumers already know and is the established leader in its space. That in itself creates a barrier. It’s a high-margin business with a large and underpenetrated growth opportunity ahead.
Q: Why do you think the business of GrubHub is sustainable?
We like to own stocks for the long term, but we constantly pay attention to fundamentals potential and competitive threats. When a business becomes unsustainable, we would typically see a slowdown in the sales or earnings growth rate and a deterioration in margins.
In GrubHub, we see a business that’s fast growing and continues to gain strength through innovative new partnerships, acquisitions, and scale This market will never be as big as Facebook’s but it still is very large with an estimated $200 billion spent by consumers on takeout.. With over 50% market share, GRUB has a lot of room for future growth with 2017 gross food sales coming in just under $4 billion dollars. Although the stock has been volatile, the company is producing strong results. The management team has shown forward thinking and we are encouraged by their recent moves and decisions.
Q: Could you give us an example of a bond holding?
When we started looking at XL Group Ltd, the global insurance and re-insurance company, we saw that it hit a very rough patch around 2008, like many in the industry, due to an aggressive investment style. A new chairman, Mike McGavick, came in and started to restructure. While the stock had been beaten up, the company had a well diversified product line and a global presence. They had seasoned managers in both the insurance and the investment businesses. The new chairman was able to leverage the many strengths that were in place while leading to solid performance for the XL bondholders.
This has been a very long-term holding for us. After it acquired Catlin Group several years ago, the size of the combined entity substantially increased. The company was better able to compete with some of the larger industry players. The most recent development was the purchase of XL by AXA, giving the bondholder another win as the bonds tightened on the news.
Q: What is your portfolio construction process?
On the equity side, we have a bottom-up portfolio construction process. Our benchmark is the S&P 500 Index. For the overall portfolio, we use a blended benchmark, which is the 60/40 (S&P 500/ Bloomberg Barclays US Aggregate Bond Index).
We own a diversified portfolio of approximately 60 companies. We feel this gives us adequate diversification and at the same time allows us to build a Fund that can outperform the Index and our peers. The Fund’s positions are not equally weighted, and instead are sized based on what we view as the likely risk and return of each company. With that, our biggest position recently was around 5% and the average position size typically ranges from 1% to 3%. Recently, we had roughly 30% of the Fund invested in our top ten positions. Our strategy is to focus on the best ideas that we hold, but also to maintain a diversified portfolio.
We can’t own more than 25% in any industry and we tend to be overweight or underweight the Index in different sectors. Since our process is fundamentally driven, as we look for businesses with the best prospects for longer-term sales and earnings growth, we tend to have higher exposure to sectors like consumer discretionary, healthcare and information technology. On the other hand, we will be out certain sectors where we don’t find any worthy longer-term growth opportunities. For instance at the end of 2017, the fund was not invested in materials, utilities and telecom services.
On the fixed-income side, we start with the index. Our exposure to U.S. Treasuries is about 17%, which is a significant underweight relative to the benchmark. We have a similar overweight in corporate bonds. Our exposure in the securitized sector is neutral vs. the Index.
We view setting the Fund’s risk appetite as a starting point, which includes both interest rate and credit risk. Once we establish the sector exposure, we start looking for individual credits and we set a duration target relative to the index. In general, we don’t deviate more than six months from the index duration in either direction.
Last year we had large exposure to energy, particularly refiners and exploration, and that did well for us. We were heavily invested in BBBs, but are moving towards higher quality in 2018, as spread widening has been more pronounced in the lower-quality names.
Q: How do you define and manage risk?
We believe that the best way to reduce risk is to own a diversified, yet focused portfolio of high-quality and fast-growing companies for the long term. We know our companies well and focus on understanding where their businesses are going in the long run. If a company’s business fundamentals deteriorate, we will sell it, but if their growth prospects remain attractive, we will remain invested.
Another way we control risk is by owning companies with business models that we understand. We find it’s a lot easier to understand companies with secular growth drivers than the very cyclical ones, because there are many factors the companies cannot control and we cannot predict. Through our fundamental research process, we make sure to understand the downside and upside potential of every stock we own.
Another element is right sizing the positions based on the risks and opportunities we see. Companies with the best risk/return are usually at the top of the portfolio, while those that may be growing faster but present higher risk, would be smaller positions in the Fund.
Our portfolio is diversified through an assortment of unique and strong businesses. With roughly 60 holdings, we have built a diversified fund, which tends to be less risky because of its large-cap and high-quality bias. Overall, risk control on the equity side comes from selecting companies with secular growth drivers, strong balance sheets, good management team and positions that do not depend strongly on the economic environment.
In the fixed-income universe, we favor large liquid issues, or benchmark issues, to mitigate the liquidity risk. We don’t own a lot of private placements because of the execution risk. We focus on credit risk and look for diversification within the credits. We analyze each credit to see how shareholder friendly this company has been. We wait for better entry points in terms of spreads.
Interest rate risk is harder to control within a fund. We don’t ”hug” the benchmark, but we also don’t stray too far away from it. So, the key risk controls in fixed income are maintaining liquidity, monitoring credit metrics, and watching the spreads or relative value.
The worst-case scenario, of course, is the loss of capital. Since we don’t buy the lowest rated high-yield bonds that are more likely to go bankrupt, loss of capital is a small risk for us. We are concerned more about underperformance, which would happen if our bonds widen more than the bonds in the index or the bonds of our peers. Our goal is strong steady performance relative to our Index and to our peers.
Q: What lessons did you learn from the financial crisis of 2008-2009?
If there was a lesson to be learned, it was about the value of liquidity. We own fixed-income issues that tend to be large public benchmark issues. They’re generally more liquid than some older issues with fewer bonds outstanding or those that are private placements.