Small Cap Secret Sauce
Sentinel Small Company Fund
Scott T. Brayman
Author: John Fitzgibbon
Last Update: , : For complete profile and charts on Sentinel Small Company Fund
|When Scott Brayman asserts that his fund’s worst days are still better than most people’s best days, it doesn’t sound too hollow next to the fund’s top-quintile performance in the past 5-year and 10-year periods. Looking for small to mid-sized companies with some “secret sauce” is no revolutionary concept, but Brayman’s execution on it deserves credit.
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Q: I noticed that Morningstar has your portfolio broken into three basic industries: Information (11.1%), Service (58%), and Manufacturing (30.8%). Is this by design or by the market outlook of the sectors?
That’s Morningstar. I don’t view it that way. I think the high service component is because for the most part we like the kind of businesses that make high returns and tend not to be manufacturing companies. Instead, they tend to be service oriented; a business where somebody has a solution to a widespread problem and that solution doesn’t require a lot of capital. We don’t have a lot of information technology because that product-obsolescence sector factor is a pretty high hurdle to clear. We look very much like the S&P 600, there’s no dramatic underweights or overweights on a sector basis. We think the small cap universe is inefficient enough so that we can add enough value over time through stock selection that we don’t need to take a lot of sector risk or make big sector bets.
Q: Morningstar reported your turnover ratio was at 58%. Is that about right?
Yes, let me put a little bit of color in that because is doesn’t necessarily reflect a complete transition in names. About 60% of our turnover is just trimming or adding to the same names. We’ve got a lot of key names, but we move the position size up or down based upon its valuation. In volatile markets like we have had last couple of years it has created a lot of opportunities. A lot of the volatility has taken place above and below fair value, so we are constantly selling and buying back. We are not constantly coming up with a whole lot of new names as 58% might imply.
Q: How fast can you act on an investment decision? As an example, I noticed on Friday, April 25, 2003, that Credit Suisse First Boston downgraded Viad, one of your largest holdings, to “Neutral” from “Outperform.” On others, how would this impact your holdings?
We typically are not going to respond or act solely on the basis of a change in opinion by a sell-side analyst. What we will respond to is new information that we either develop through a mosaic from the marketplace or other sources, company reports, competitor press releases or when management delivers the news. When we get information that says, ‘this business has a problem,’ we take a hard look at that. There is one time you should definitely believe management; it is when they tell you they have a problem.
Q: How many stocks do you have on your “approved list?”
We do not have an approved list. We have a portfolio, which I would call the approved list and that’s 86 names right now. Then we have a focus list of names that are warm to us and that’s around 50.
Q: Is that by design or by the marketplace?
I keep the focus list and I limit it to 50. Focus and concentration are one of the keys to excellence. One could very easily argue that we should limit that list to maybe 10, so it has to stay under 50.
Q: It is like the old Boy Scout marching song, “Be Prepared.”
That’s the big part of our game! Absolutely. That’s why all the work we are doing today could be money in the bank tomorrow even though it might not be in your price range today. The effort is going towards building a backlog and pipeline of potential ideas. That’s when you go ‘How quickly can you act?’ Well, we can often act quickly because of prior work and keeping track of all that work electronically, allows us to be prepared.
Q: What’s your outlook for the market for the balance of the year?
You know, we just don’t know. On the one hand, valuations will tell us there’s not a lot of upside left. On the other hand, we can see tremendous pressure on all the short interest out there that could propel a significant rally. I think a lot has to do with the economic news we get in the second half. I think we’ll get a post-war bounce but because of a lot of the excesses from the bubble, I’m not sure it lasts. We just may need more time before we get into a sustained up move. So there’s a lot of cross currents that cause us to say that we just don’t know. But our discipline just tells us to stay focused on quality businesses and sell them when they’re overpriced and reinvest in the ones that are most undervalued.
Q: Anything you would like to add?
We always like to try to leave with the message that everyone on this team feels incredibly fortunate, blessed even, to do this for a living. We think it’s a privilege to manage other people’s money. We realize our worst days are probably still better than most people’s best days.
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