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Selective and Risk Aware for Long-Term Value
Advisory Research International Small Cap Value Fund
Interview with: Kevin Ross

Author: Ticker Magazine
Last Update: Nov 10, 11:09 AM EST
Most international mutual funds are focused on large-cap companies and global factors, but there are smaller gems in the under-researched international space that are just as attractive. Kevin Ross, portfolio manager of the Advisory Research International Small Cap Value Fund, relies on a structured investment process in discovering undervalued stocks with operational or strategic paths to unlock the value while preserving capital through the investment cycle.

“We combine rigorous fundamental research and quantitative tools to add value from a bottom-up security selection standpoint, and emphasize capital preservation to compound capital long term.”
Q: Would you give an overview of the history and mission of the fund?

A: Advisory Research, Inc. was founded in 1974 as a domestic value manager. The Small Cap Value strategy launched in 1987 and the international business started in 2006, leveraging a similar investing philosophy.

The firm manages more than $7.5 billion in assets across a broad spectrum of traditional long only and alternative investments. This mutual fund originated in 2010, and I joined the team in 2013.

We are disciplined, long-term value managers focused on small-cap companies with market caps below $5 billion, whereas most international strategies primarily have a large-cap and growth-oriented focus.

We combine rigorous fundamental research and quantitative tools to add value from a bottom-up security selection standpoint, and emphasize capital preservation to compound capital long term. That generally manifests itself in below benchmark portfolio average multiples, price to book, price to earnings, or EV to EBITDA, and better downside capture and lower standard deviations versus the fund’s benchmark, the MSCI EAFE Small Cap Value Index.

Our benchmark includes all developed market countries outside of the U.S. The largest countries in our portfolio currently include Japan, Germany, UK, Sweden, Switzerland, Norway, Australia, and Canada.

Q: What core beliefs drive your investment philosophy?

A: We are value-oriented. Security selection drives our alpha, so we don’t make large country /or currency bets. We incorporate a variety of quantitative and risk management tools in conjunction with deep fundamental and bottoms up company specific research. To generate superior investment outcomes, we seek to outperform consistently, through various investment cycles.

Capital preservation and downside protection come into play even before we think about an investment’s upside opportunity.

Q: Would you describe your investment process?

A: We have a disciplined four-step investment process. The first step is identifying our opportunity set; the second and third determining downside protection and upside potential; and the fourth, deciding the appropriate weightings for the securities that we want to purchase.

To identify our opportunity set, we first narrow our universe using our proprietary quantitative screening tool which we call the alpha scoring tool. We rank the entire universe of stocks based on a multifactor model that incorporates 56 different fundamental factors which get reweighted every month.

Once we arrive at the top 20%, we narrow the list even further identifying those that look attractive relative to underlying fundamental valuation and those securities exhibiting strong, defensive balance sheets.

Step two, downside protection, consists of our research analysts performing financial and business downside risk analyses, including historical and peer valuation analyses, to quantify downside potential in a bear-case scenario. We want businesses that exhibit cash flow generation and profitability throughout the business cycle.

We eliminate stocks that are deep turnarounds, unprofitable, excessively overleveraged, or exhibit risk of financial distress. We analyze closely at management team quality and corporate governance, which are particularly important when screening international investments. The stocks that fail step two go into our knowledge database for future consideration should circumstances change.

In the third step we identify upside potential, including management’s ability to unlock and enhance company value. We research capital allocation to ensure management uses capital most effectively, and analyze opportunities to improve corporate governance.

We like catalysts, so we pinpoint potential catalysts, without insisting on strict time horizons. We also analyze the industry business cycle and potential changes in the industry outlook and competitive landscape that drive value, and look for asset utilization improvements.

The fourth and final step is determining an appropriate weighting for a new security based on how it fits into the portfolio. We utilize an optimization engine combined with our fundamental conviction to determine an appropriate portfolio weighting. This minimizes portfolio risk and ensures we do not take on any unintended bets in the portfolio.

A key part of our philosophy is to ensure we drive alpha through portfolio security selection and avoid taking on excessive amounts of country, currency, style or factor risks.

Q: How do you standardize the accounting statements of different countries?

A: We don’t try to convert everything over to one standard. Instead, we typically take each company at face value, making adjustments as needed depending on classification differences and accounting standards.

For example, in Hong Kong, real estate companies disclose fair market value of their real estate quarterly or semi-annually, when they report their earnings. Other jurisdictions do not make this fair value change. So, when comparing a real estate company on price-to-book value basis, we recognize that Hong Kong companies will trade at lower multiples compared to global peers and make adjustments as necessary to compare on an apples to apples basis.

Q: Do you take a macro view in your strategy?

A: Macro is something we monitor; however, it doesn’t drive investment decision making. It comes in occasionally, from a risk management standpoint in more extreme scenarios, but primarily shows up in our bottom-up analysis—calculating our upside/downside scenarios and talking to management teams and understanding industry and company outlooks.

Q: Can you provide an example of your research process?

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